Auditing – Assignment and Discussion questions Page 1 of 2

Chapter 2
Assignment questions (Ch2)

2-1 [LO1] Define fraud and explain the two types of misstatements that are relevant to auditors’
consideration of fraud.
CG & effective CG
2-25 [LO6] CG relevant components: 1. Board 2. Independent directors 3. committees 4. IA/EA
The following factors describe a potential audit client. For each factor, indicate whether it is indicative of
poor corporate governance. Explain the reasoning for your assessment. Finally, identify the risks to
reliable financial reporting that are associated with each factor.

a. The company is in the financial services sector and has a large number of consumer loans, including
mortgages, that are outstanding.

b. The CEO’s and CFO’s compensation is based on three components: (a) base salary, (b) bonus based on
growth in assets and profits, and (c) significant stock options.

c. The audit committee meets semiannually. It is chaired by a retired CFO who knows the company well
because she had served as the CFO of a division of the firm. The other two members are local community
members—one is the president of the Chamber of Commerce and the other is a retired executive from a
successful local manufacturing firm.

d. The company has an internal auditor who reports directly to the CFO and makes an annual report to
the audit committee.

e. The CEO is a dominating personality—not unusual in this environment. He has been on the job for six
months and has decreed that he is streamlining the organization to reduce costs and centralize authority
(most of it in him).

f. The company has a loan committee. It meets quarterly to approve, on an ex-post basis, all loans over
$300 million (top 5% for this institution).

g. The previous auditor has resigned because of a dispute regarding the accounting treatment and fair
value assessment of some of the loans.
Auditing – Assignment and Discussion questions Page 2 of 2
Chapter 2
Discussion questions (We will do the followings in the tutorial.)

2-10 [LO4]
Each of the following scenarios is based on facts in an actual fraud. Categorize each scenario as primarily
indicating (1) an incentive to commit fraud, (2) an opportunity to commit fraud, or (3) a rationalization to
commit fraud. State your reasoning for each categorization.

a) There was intense pressure to keep the corporation’s stock from declining further. This pressure came
from investors, analysts, and the CEO, whose financial well being was significantly dependent on the
corporation’s stock price.

b) A group of top-level management was compensated (mostly in the form of stock options) well in excess
of what would be considered normal for their positions in this industry.

c) Top management of the company closely guards internal financial information, to the extent that even
some employees on a need-to-know basis are denied full access.

d) Managing specific financial ratios is very important to the company, and both management and
analysts are keenly observant of variability in key ratios. Key ratios for the company changed very little
even though the ratios for the overall industry were quite volatile during the time period.

e) In an effort to reduce certain accrued expenses to meet budget targets, the CFO directs the general
accounting department to reallocate a division’s expenses by a significant amount. The general
accounting department refuses to acquiesce to the request, but the journal entry is made through the
corporate office. An accountant in the general accounting department is uncomfortable with the journal
entries required to reallocate divisional expenses. He brings his concerns to the CFO, who assures him
that everything will be fine and that the entries are necessary. The accountant considers resigning, but he
does not have another job lined up and is worried about supporting his family. Therefore, he never voices
his concerns to either the internal or external auditors.

f) Accounting records were either nonexistent or in a state of such disorganization that significant effort
was required to locate or compile them.