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Considering the Risk of Frauds, Errors
and Non-compliance with Laws and Regulations
SOLIMAN/UY/AGUILA/RICAFRENTE
October 2023
Summary of Auditor’s Responsibility for Fraud, Error and Non-compliance with Laws and Regulations
Non-compliance with laws & regulations
Errors
Fraud
Direct effect
Indirect effect
Relate primarily to entity’s
operations but does not have
a direct effect on an entity’s
financial statements. Noncompliance may result in
fines, litigation or other
consequences that may have
a material effect on the
financial statements.
Unintentional
misstatements or
omissions
Intentional
misstatements or
omissions
Amounts and
disclosures, as a
result of
compliance, are
reported on the
financial
statements
Examples
Mistake in processing
accounting data, incorrect
accounting estimates due
to oversight, mistakes in
application of accounting
principles
Two types—
fraudulent financial
reporting
(falsification of
accounting records)
and
misappropriation of
assets
(embezzlement or
theft)
Tax and pension
laws and
regulations
Terms of an operating license,
regulatory solvency
requirements, or
environmental regulations.
Detection
responsibility
1. Assessment of risk of
material misstatement.
2. Based on assessment,
design audit to provide
reasonable assurance
of detection of material
misstatements.
3. Exercise due care in
planning, performing,
and evaluating results
of audit procedures,
and proper degree of
professional skepticism
to achieve reasonable
assurance of detection.
(Same as for errors)
(Same as for
errors)
1. Be aware of possibility
that they may have
occurred.
2. Inquire of management
and TCWG regarding
compliance.
3. Inspect correspondence
with regulatory authorities
4. 4. If specific information
comes to attention on an
illegal act with a possible
material indirect financial
statement effect, apply
audit procedures
necessary to determine
whether illegal act has
occurred.
Reporting
responsibility
Modify auditor’s reports for
material misstatement or
inability to obtain sufficient
and appropriate audit
evidence.
(Same as for errors)
(Same as for
errors)
(Same as for errors)
Definition
1. What differentiates fraud from an error?
a. Materiality.
b. Effect on misstatements.
c. Intent.
d. Frequency of occurrence.
2. The following are examples of error, except
a. A mistake in gathering or processing data from
which financial statements are prepared.
b. An incorrect accounting estimate arising from
oversight or misinterpretation of facts.
c. A mistake in the application of accounting principles
relating to measurement, recognition, classification,
presentation, or disclosure.
d. Misrepresentation in the financial statements of
events, transaction or other significant information.
3. The risk of not detecting a material misstatement
resulting from fraud is higher than the risk of not
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detecting a material misstatement resulting from error
because
a. The effect of fraudulent act is likely omitted in the
accounting records.
b. Fraud is ordinarily accompanied by acts specifically
designed to conceal its existence, and auditors do
not make legal determinations of whether fraud has
actually occurred.
c. Fraud is always a result of connivance between or
among employees.
d. The auditor is responsible to detect errors but not
fraud.
4. The two types of intentional misstatements that are
relevant to the auditor’s consideration of fraud include,
misstatements resulting from fraudulent financial
reporting
and
misstatements
resulting
from
misappropriation of assets.
Fraudulent financial
reporting least likely involve
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a.
Deception such as manipulation, falsification
(including forgery), or alteration of accounting
records or supporting documents from which the
financial statements are prepared
b. Misrepresentation in, or intentional omission from,
the financial statements of events, transaction or
other significant information
c. Intentional misapplication of accounting principles
relating to measurement, recognition, classification,
presentation, or disclosure
d. Embezzling receipts, stealing physical assets or
intellectual property, causing an entity to pay for
goods and services not received, or using an entity’s
assets for personal use.
5. Who is most likely to perpetrate fraudulent financial
reporting?
a. Members of the board of directors
b. Production employees
c. Management of the company
d. The internal auditors
6. 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.
7. In comparing management fraud with employee fraud,
the auditor’s risk of failing to discover the fraud is
a. Greater for employee fraud because of the higher
crime rate among blue collar workers
b. Greater for management fraud because of
management’s ability to override existing internal
controls that is always presumed to exist in an audit
of financial statements.
c. Greater for employee fraud because of the larger
number of employees in the organization
d. Greater for management fraud because managers
are inherently smarter than employees
8. Which statement(s) is(are) incorrect regarding the
auditor’s responsibility to consider fraud and error in an
audit of financial statements?
a. The auditor is not and cannot be held responsible
for the prevention of fraud and error being the
primary responsibility of both the management and
those charged with governance.
b. When planning and performing audit procedures
and evaluating and reporting the results thereof,
the auditor should consider the risk of
misstatements in the financial statements resulting
from fraud.
c. In planning the audit, the auditor should discuss
with other members of the audit team the
susceptibility of the entity to material statements in
the financial statements resulting from fraud or
error and exercise professional skepticism, which is
the best method of the auditor to detect fraud.
d. The auditor should design audit programs that will
provide reasonable assurance that material errors
and fraud will be detected in the ordinary course of
the examination.
9. When comparing the auditor’s responsibility for
detecting employee fraud and for detecting errors, the
profession has placed the responsibility:
a. more on discovering errors than employee fraud.
b. more on discovering employee fraud than errors.
c. equally on discovering either one.
d. on the senior auditor for detecting errors and on the
manager for detecting employee fraud.
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10. Which of the following represents the primary difference
between an audit and forensic accounting?
a. An audit has the focused responsibility to detect
fraud in the client organization while forensic
accounting sets out to prevent fraud.
b. An audit has no responsibility for fraud while
forensic accounting provides an audit specific to
material fraud discovery.
c. An audit must follow Generally Accepted Auditing
Standards while the forensic accountant is bound to
Generally Accepted Fraud Standards.
d. An audit utilizes sampling techniques to detect
material misstatements while forensic accounting
examines the entire population of fraudulent
transactions.
11. Sources of information gathered to assess fraud risks
usually do not include:
a. Analytical procedures.
b. Inquiries of management and others within the
entity.
c. Communication among audit team members.
d. Review of corporate charter and bylaws.
12. When planning the audit, the auditor should make
inquiries of management in order to do the following,
except
a. Obtain an understanding of management’s
assessment of the risk that the financial statements
may be materially misstated as a result of fraud.
b. Obtain an understanding of the accounting and
internal control systems management has put in
place to address fraud and error.
c. Determine whether management and other within
the entity (e.g., internal audit function) have
knowledge of any actual, suspected or alleged fraud
affecting the entity.
d. Provide useful information concerning the risks of
material misstatements in the financial statements
resulting from management fraud.
13. According to professional audit standards, how might an
understanding of the nature of fraud that may occur in
the client organization best be identified by the audit
firm?
a. Fraud training courses from actual corporate fraud
ex-criminals.
b. Conducting a brainstorming meeting with the
members of the audit team.
c. Circulating a survey to the client company
employees for completion.
d. Discussions with other CPA firms.
14. Which of the following issues is normally part of the
“brainstorming” session required by PSAs?
a.
b.
c.
d.
How assets could be
misappropriated
Yes Yes Yes No
How and where the entity’s
financial statements are
susceptible to material
misstatements due to
Yes Yes Yes Yes
fraud
The need for professional
skepticism
Yes No
No Yes
The audit team’s response to
potential fraud risks
Yes Yes No
No
15. The fraud triangle consists of three components
(incentive or pressure, opportunity, and attitude or
rationalization). Which of the three components are
present in most every fraud?
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a.
All three factors are usually present when fraud
occurs.
b. Pressure and opportunity
c. Opportunity and rationalization
d. Rationalization and pressure
16. Categories of fraud risk factors (whose presence often
has been observed in circumstances where frauds have
occurred) in relation to misstatements arising from
misappropriation of assets and fraudulent financial
reporting
are
opportunities,
attitudes
or
rationalizations, and pressures or incentives. Which of
the following creates an opportunity for fraud to be
committed in an organization?
a. Management demands financial success or is
aggressive in its application of accounting rules.
b. Poor internal control.
c. Commitments tied to debt covenants.
d. Finding loopholes in the accounting rules to achieve
earnings targets.
17. The following are examples of circumstances that may
indicate the possibility that the financial statements
may contain a material misstatement resulting from
fraud, except
a. Transactions that are recorded in a complete or
timely manner or are properly recorded as to
amount, accounting period, classification, or entity
policy.
b. Unsupported
or
unauthorized
balances
or
transactions.
c. Last-minute adjustments that significantly affect
financial results or unusual journal entries.
d. Tips or complaints to the auditor about alleged
fraud.
18. The following are examples of circumstances that may
indicate the possibility that the financial statements
may contain a material misstatement resulting from
fraud, except
a. Missing documents.
b. Documents that appear to have been altered.
c. Unavailability of other than photocopied or
electronically
transmitted
documents
when
documents in original form are expected to exist.
d. Significant explained items on reconciliations.
19. Which of the following is most likely to be presumed to
represent fraud risk on an audit?
a. Capitalization of repairs and maintenance into the
property, plant, and equipment asset account.
b. Improper revenue recognition.
c. Improper interest expense accrual.
d. Introduction of significant new products.
20. Statement 1:
Auditors are required to perform
extended audit procedures to detect material errors and
irregularities if previously performed examinations
indicate that they may exist.
Statement 2: Audit procedures that are effective for
detecting an unintentional misstatement may be
ineffective for an intentional misstatement that is
concealed through collusion.
a. True, true
c. False, true
b. True, false
d. False, false
21. Which of the following is most likely to be an overall
response to fraud risks identified in an audit?
a. Supervise members of the audit team less closely
and rely more upon judgment.
b. Only use certified public accountants on the
engagement.
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c.
Place increased emphasis on the audit of objective
transactions rather than subjective transactions.
d. Use less predictable audit procedures.
22. Which of the following is most likely to be a response to
the auditor's assessment that the risk of material
misstatement due to fraud for the existence of inventory
is high?
a. Observe test counts of inventory at certain locations
on an unannounced basis.
b. Perform analytical procedures rather than taking
test counts.
c. Request that inventories be counted prior to yearend.
d. Request that inventory counts at the various
locations be counted on different dates so as to
allow the same auditor to be present at every count.
23. As part of designing and performing procedures to
address management override of controls, auditors
must perform which of the following procedures?
a.
b.
c.
d.
Review accounting estimates
for biases
Yes Yes Yes No
Examine all journal entries
above materiality
Yes No Yes Yes
Examine adjusting entries
Yes Yes No Yes
Review unusual transactions
Yes Yes No
No
24. Communication of a misstatement resulting from fraud,
or a suspected fraud, or error to the appropriate level
of management on a timely basis is important because
it enables management to take action as necessary.
Ordinarily, the appropriate level of management is
a. At least equal to level of persons who appear to be
involved with misstatements or suspected fraud
b. At least one level above persons who appear to be
involved with the misstatement or suspected fraud
c. The audit committee of the board of directors
d. The head of internal audit department
25. The auditor least likely obtains written representations
from management that:
a. It acknowledges its responsibility for the
implementation and operations of accounting and
internal control systems that are designed to
prevent and detect fraud and error.
b. It has disclosed to the auditor its knowledge of fraud
or suspected fraud affecting the entity involving
employees who have significant roles in internal
control only.
c. 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,
regulations or others.
d. 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.
26. The auditor may encounter exceptional circumstances
that bring into question the auditors ability to continue
performing the audit, including where
a. The entity does not take the remedial action
regarding fraud that the auditor considers
necessary in the circumstances, even when the
fraud is not material to the financial statements
b. The auditor’s consideration of the risk of material
misstatement resulting from fraud and the results
of audit tests indicate a significant risk of material
and pervasive fraud
c. The auditor has significant concern about the
competence or integrity of management or those
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charged with governance that affect the auditor's
ability to rely on management's representations.
d. All of the above
27. Which statement is incorrect regarding the auditor’s
consideration of laws and regulations in an audit of
financial statements?
a. Noncompliance refers to acts of omission or
commission by the entity being audited which are
contrary to prevailing laws and regulations
b. Noncompliance includes transactions entered into
by, or in the name of, the entity, or on its behalf,
by TCWG, management or employees.
c. Noncompliance includes personal misconduct of the
entity’s management or employees unrelated to the
business activities of the entity.
d. In the absence of evidence to the contrary, the
auditor is entitled to assume the entity is in
compliance with applicable laws and regulations
affecting the client.
28. Which of the following would most likely be deemed a
direct-effect illegal act?
a. Violation of employment laws.
b. Violation of environmental regulations.
c. Violation of income tax laws.
d. Violation of civil rights laws.
29. Which of the following illegal acts should an audit be
designed to obtain reasonable assurance of detecting?
a. Securities purchased by relatives of management
based on knowledge of inside information.
b. Accrual and billing of an improper amount of
revenue under government contracts.
c. Violations of antitrust laws.
d. Price fixing.
30. Which of the following statements is usually true?
a. It is easier for the auditor to uncover fraud than
errors.
b. It is easier for the auditor to uncover indirect-effect
illegal acts than fraud.
c. The auditor’s responsibility for detecting indirecteffect illegal acts is similar to the responsibility to
detect fraud.
d. The auditor’s responsibility for detecting directeffect illegal acts is similar to the responsibility to
detect fraud.
31. Which of the following is incorrect about the auditor’s
responsibility for evaluating noncompliance by the
entity to laws and regulations?
a. It is the responsibility of management, with the
oversight of those charged with governance, to
ensure that the entity’s operations are conducted in
accordance with laws and regulations, including
compliance with laws and regulations that
determine the form or content of the entity’s
financial statements. This includes responsibility for
the prevention and detection of non-compliance
with laws and regulations.
b. An audit cannot be expected to detect
noncompliance with all laws and regulations.
Detection
of
noncompliance,
regardless
of
materiality,
requires
considerations
of
the
implications for the integrity of management or
employees
c. Generally, the further removed non-compliance is
from the events and transactions reflected in the
financial statements, the more likely the auditor is
to become aware of it or to recognize the possible
non-compliance. This is because an illegal act by the
client often relate to operating aspects rather than
accounting aspects.
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d. 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.
32. Which of the following is incorrect regarding the
auditor’s consideration of laws and regulations
applicable to the entity?
a. The auditor shall obtain a general understanding of
applicable laws and regulations to the entity.
b. The auditor shall identify and assess risk of material
misstatement of financial statements relating to
non-compliance with laws and regulations.
c. The auditor shall obtain sufficient appropriate audit
evidence regarding compliance of all types of laws
and regulations applicable to the entity.
d. The auditor shall respond appropriately in instances
of identified or suspected non-compliance with all
types laws and regulations.
33. In considering indirect effect laws and regulations in an
audit of financial statements, an auditor shall
a. Inquire of management and those charged with
governance.
b. Inspect
correspondences
with
regulatory
authorities.
c. Both a and b.
d. Neither a nor b.
34. According to PSA 250 (Consideration of Laws and
Regulations in an Audit of Financial Statements), the
following are indications that noncompliance may have
occurred, except
a. Investigation by government departments or
payment of fines or penalties
b. Adverse media comment
c. Authorized transactions or properly recorded
transactions
d. Purchasing at prices significantly above or below
market price
35. Examples of the type of information that may come to
the auditor's attention that may indicate that
noncompliance with laws or regulations has occurred
least likely include
a. Payments for unspecified services or loans to
consultants,
related
parties,
employees
or
government employees.
b. Payments for goods or services made other than to
the country from which the goods or services
originated.
c. Unauthorized transactions or improperly recorded
transactions.
d. Payments
with
proper
exchange
control
documentation.
36. When an auditor identifies or suspects instances of noncompliance with laws and regulations in relation to audit
of financial statements, the auditor shall
a.
b.
c.
d.
Obtain understanding of the
nature of the act.
Yes Yes Yes No
Evaluate possible effect of
noncompliance on financial
statements.
Yes No Yes Yes
Discuss the matter with
management and TCWG.
Yes Yes No Yes
Consider obtaining legal
Yes Yes No
No
advice.
Evaluate other audit
implications.
Yes Yes No
No
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37. Which of the following is incorrect about the auditor’s
responsibility for evaluating noncompliance by the
entity to laws and regulations?
a. When the auditor becomes aware of information
concerning a possible instance of noncompliance,
the auditor shall obtain an understanding of the
nature of the act and the circumstances in which it
has occurred and evaluate the possible effect on the
financial statements.
b. If the auditor has identified or suspects
noncompliance with laws and regulations, the
auditor shall determine whether the auditor has a
responsibility to report the identified or suspected
noncompliance to parties outside the entity.
c. The auditor shall document identified or suspected
non-compliance with laws and regulations but not
the results of discussion with management, and
where applicable, those charged with governance
and other parties outside the entity.
d. The auditor may withdraw from the engagement
when the entity does not take the remedial action
that the auditor considers necessary in the
circumstances, even when the noncompliance is not
material to the financial statements or affects
auditor’s
ability
to
rely
on
management
representations.
38. In assessing whether management has overlooked
relevant laws and regulations, the auditor would
perform all of the following except
a. Obtain written representations from management.
b. Review relevant portions of grant and loan
agreements.
c. Confirm grant arrangements with granting
agencies.
d. Discuss laws and regulations with the entity's chief
financial officer and legal counsel.
39. 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
a. Increase the assessed level of control risk.
b. Recommend remedial actions to the audit
committee.
c. Determine the reliability of management’s
representations.
d. Evaluate the effect on the financial statements and
may consider seeking legal advice especially when
involving members of senior management,
including members of the board of directors.
40. Which of the following is the auditor least likely to do
when aware of an illegal act?
a. Discuss the matter with the client’s legal counsel.
b. Obtain evidence about the potential effect of the
illegal act on the financial statements.
c. Consider the impact of the illegal act on the
relationship with the company’s management.
d. Contact the local law enforcement officials
regarding potential criminal wrongdoing.
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