Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao

Since 1977
AT.3215
Considering the Risk of Frauds, Errors SOLIMAN/UY/RICAFRENTE
and Non-compliance with Laws and Regulations MAY 2022

References:
a. PSA 240 (Redrafted), The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
b. PSA 250 (Redrafted), Considerations of Laws and Regulations in an Audit of Financial Statements

LECTURE NOTES
Auditor's Responsibility for Fraud and Error
The risk of the auditor not detecting management fraud is
Introduction greater than employee fraud, because management may
override otherwise effective internal controls.
The auditor is responsible for obtaining reasonable
assurance that the financial Statements taken as a whole Responsibility of Management and Those Charged
are free from material misstatement, whether caused with Governance (TCWG) vs. that of the Auditor
by fraud or error. Hence, the auditor’s responsibility for the
detection of fraud and error is essentially the same. The primary responsibility for the prevention and detection
of fraud rests with both TCWG of the entity and
Fraud refers to an intentional act by one or more individuals management. Management shall establish a control
among management, those charged with governance environment and implement internal control policies and
(TCWG), employees, or third parties, involving the use of procedures to prevent and detect fraud. On the other hand,
deception to obtain an unjust or illegal advantage. While, TCWG, through its oversight function, shall ensure the
error pertains to unintentional misstatements or omissions integrity of accounting and financial reporting systems and
in financial statements, including the omission of an amount that appropriate controls are in place.
or disclosure. Differentiating fraud from error requires
professional judgment. The risk of not detecting fraud is On the other hand, the auditor’s responsibility is to obtain
higher than that of error because fraud may be concealed, reasonable assurance about whether the financial
especially if through collusion. statements taken as a whole are free from material
misstatement, whether caused by fraud or error. The
Although fraud is a broad legal concept, the auditor is auditor is not responsible for discovering fraud, and is not
concerned with fraud that causes a material misstatement and cannot be held responsible for the prevention of
in the financial statements. In addition, the auditor does fraud. Unless the auditor has reason to believe the
not make legal determinations of whether fraud has actually contrary, the auditor may accept records and documents as
occurred. genuine. An audit rarely involves the authentication of
documents.
Types of Fraud
Summary of Auditor’s Consideration of Fraud
In relation to audit of financial statements:
Step Approach
• fraudulent financial reporting – involves intentional • Discussion among the
misstatements, including omissions of amounts or Staff discussion engagement team
disclosures in financial statements, to deceive financial Step of the risk of (Brainstorming)
statements users, normally involves management. 1. material • Consider fraud triangle
examples are the following: misstatement • Exercise professional
§ manipulation or falsification of financial records skepticism
§ misrepresentation or intentional omission of Obtain • Make inquiries of
information in the financial statements information management and others
§ intentional misapplication of accounting policies Step
needed to • Consider results of
identify risks of analytical procedures
2.
• misappropriation of assets (theft) - involves the theft of material • Consider fraud risk factors
an entity’s assets and is often perpetrated by employees misstatement • Consider other
in relatively small and immaterial amounts. however, it due to fraud information
can also involve management and TCWG. examples of For risks identified, consider
this type of fraud are the following: Identify risks • Type of risk that may
§ embezzling receipts that may result exist
§ lapping of accounts receivable Step
3.
in a material • Significance of risk
§ entity funds sent to a personal bank account misstatement (magnitude)
§ inventory items sold personally by entity employees due to fraud • Likelihood of risk
§ goods or services paid for by the entity but not • Pervasiveness of risk
received
• Consider understanding of
§ use of entity assets for personal use Assess the internal control
identified risks • Evaluate whether internal
As to perpetrator: Step
after controls address the
4.
considering identified risks
1. Management fraud – refers to fraud involving one or
internal controls • Assess risks taking into
more members of management or TCWG.
account this evaluation
2. Employee fraud – refers to fraud involving only
employees of the entity.

Page 1 of 10 www.teamprtc.com.ph AT.3215

EXCEL PROFESSIONAL SERVICES, INC.
As risk increases
• Overall response: More
experienced staff, more
attention to accounting
policies, less predictable
procedures
• For specifically identified
risks: Consider the need
Respond to the
Step to increase the nature,
results of the
5. timing and extent of audit
assessment
procedures
• On all audits consider the
possibility of
management override of
controls (adjusting
journal entries,
accounting estimates,
unusual transactions)
• Assess risks of fraud
throughout the audit
• Evaluate analytical
procedures performed as
substantive procedures
and at overall review
Step Evaluate audit
stage
6. evidence
• Evaluate risks of fraud
near completion of
fieldwork
• Respond to
misstatements that may
be due to fraud
• Communicate all fraud to
an appropriate level of
management
• Communicate all
management fraud to
Step Communicate TCWG
7. about fraud • Communicate all material
fraud to management and
TCWG
• Determine if significant
deficiencies have been
identified
• Document steps 1-7
Document • If improper revenue
Step
consideration of recognition not
8.
fraud considered a risk,
describe why
The important concepts of the above steps further discussed
below.
Auditor’s Consideration of Fraud
Discussion Among the Engagement Team
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. The team shall set aside beliefs that
management and TCWG are honest and have integrity.
Fraud Triangle
The three conditions (the fraud triangle or characteristics)
generally present when fraud occurs are:
1. Attitudes or rationalizations – Those involved in the
fraud are able to rationalize committing a fraudulent
act. This relates to either a person committing the
fraud, or to the entity’s control environment.
Page 2 of 10 www.teamprtc.com.ph
2. Incentives or pressures – Management and employees
have an incentive (e.g., benefit or enrichment) or are
under pressure (e.g., threat of losing their job), which
provides a reason to commit fraud.
3. Opportunities – Circumstances making execution of
fraud possible. These circumstances exist when a
person is generally trusted, internal control is perceived
to be easily overridden, or the individual knows about
deficiencies in internal control.
Performing risk assessment procedures (RAP) and Related
Activities
• Management and Others within the Entity
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.
The auditor shall make inquiries of internal audit to
determine whether it has knowledge of any actual,
suspected or alleged fraud affecting the entity, and to
obtain its views about the risks of fraud.
• Those Charged with Governance (TCWG)
The auditor shall obtain an understanding of how TCWG
exercise oversight of management’s processes for
identifying and responding to the risks of fraud in the
entity and the internal control that management has
established to mitigate these risks. TCWG of an entity
have oversight responsibility for systems for monitoring
risk, financial control and compliance with the law.
The auditor shall make inquiries of TCWG to determine
whether they have knowledge of any actual, suspected
or alleged fraud affecting the entity. These inquiries are
made in part to corroborate the responses to the
inquiries of management.
• Unusual or Unexpected Relationships Identified
The auditor shall evaluate whether unusual or
unexpected relationships that have been identified in
performing analytical procedures, including those
related to revenue accounts, may indicate risk of
material misstatement due to fraud.
• Other Information
The auditor shall consider whether other information
obtained by the auditor indicates risk of material
misstatement (ROMM) due to fraud.
• Evaluation of Fraud Risk Factors
Fraud risks factors refer to events or conditions that
indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
Identifying and Assessing the ROMM Due to Fraud
The auditor shall identify and assess the ROMM due to fraud
at the financial statements level, and at the assertion level
for classes of transactions, account balances and
disclosures.
AT.3215
EXCEL PROFESSIONAL SERVICES, INC.
• Risks of Fraud in Revenue Recognition
The auditor shall, based on a presumption that there
are risks of fraud in revenue recognition, evaluate which
types of revenue, revenue transactions or assertions
give rise to such risks. Otherwise, auditor shall
document when this presumption is not applicable. For
example, when revenue recognition is a single type of
simple revenue transaction, e.g., leasehold revenue
from a single unit rental property.
The auditor shall treat assessed ROMM due to fraud as
significant risks and accordingly, obtain an
understanding of the entity’s related controls, including
control activities.
Responding to Assessed ROMM Due to Fraud
• Overall Responses
The auditor shall determine overall responses to
address the assessed risk of material misstatement due
to fraud at the financial statements level.
• Audit Procedures Responsive to Assessed Risks of
Material Misstatement Due to Fraud at the Assertion
Level
The auditor shall design and perform further audit
procedures whose nature, timing and extent are
responsive to the assessed risk of material
misstatement due to fraud at the assertion level.
• Audit Procedures Responsive to Risks Related to
Management Override of Controls
Management is in a unique position to perpetrate fraud
because of management’s ability to manipulate accounting
records and prepare fraudulent financial statements by
overriding controls that otherwise appears to be operating
effectively. Due to the unpredictable way in which such
override could occur, it is a risk of material misstatement
due to fraud and thus a significant risk.
Irrespective of the auditor’s assessment of the risks of
management override of controls, the auditor shall design
and perform audit procedures to:
1. Test the journal entries and other adjustments made in
the preparation of the financial statements.
2. Review accounting estimates for biases.
3. For significant transactions that are outside the normal
course of business for the entity, or appear to be
unusual, the auditor shall evaluate business rationale
(or the lack thereof) of the transactions.
Evaluating Audit Evidence and Results of Audit
Based on the audit procedures performed and the audit
evidence obtained, to evaluate whether the assessments of
the risk of material misstatement at the assertion level
remain appropriate. This evaluation is primarily a
qualitative matter based on the auditor’s judgment.
• Analytical Procedures Performed in the Overall Review
of the Financial Statements
The auditor shall evaluate whether analytical
procedures that are performed when forming an overall
conclusion as to whether the financial statements as a
Page 3 of 10 www.teamprtc.com.ph
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.
• Consideration of Identified Misstatements
The auditor’s actions depend on whether the fraud that
has been discovered or suspected is material or
immaterial:
• If immaterial:
§ Refer to appropriate level of management (one level
above the person involved)
§ Gain satisfaction no financial statements effect
• If material or unable to evaluate whether material or
immaterial:
§ Consider implications for audit, e.g., reliability of
management representations
§ Investigate further, i.e., discuss with appropriate
level of management (one level above the person
involved)
§ Obtain evidence of fraud and its effects
§ Suggest client consult legal counsel
Communication of Misstatements due to Fraud
In the exceptional circumstances where the auditor has
doubts about the integrity or honesty of management or
TCWG, the auditor may consider it appropriate to obtain
legal advice to assist in determining the appropriate course
of action.
• Communication To Management
The communication enables management to act on a
timely basis. The communication is made even if the
matter might be considered inconsequential (for
example, a minor defalcation by an employee at a low
level in the entity’s organization). The determination
whom to communicate is a matter of professional
judgment which normally is at least one level above the
person involved.
• Communication With Those Charged With Governance
The auditor’s communication with TCWG may be made
orally or in writing. Due to the nature and sensitivity of
fraud involving senior management, or fraud that
results in a material misstatement in the financial
statements, the auditor reports such matters on a
timely basis and may consider it necessary to also
report such matters in writing.
In some cases, the auditor may consider it appropriate
to communicate with TCWG when the auditor becomes
aware of fraud involving employees other than
management that does not result in a material
misstatement. Similarly, TCWG may wish to be
informed of such circumstances.
• Communications to Regulatory and Enforcement
Authorities
The auditor’s professional duty to maintain the
confidentiality of client information may preclude
reporting fraud to a party outside the client entity.
However, the regulatory requirements, statute, the law
AT.3215
EXCEL PROFESSIONAL SERVICES, INC.
or courts of law overrides this duty. For example, under
a BSP requirement, the auditor of a financial institution
has a statutory duty to report the occurrence of fraud
to the BSP. Also, under an SEC requirement, the auditor
has a duty to report material audit findings, such as
those involving fraud or error.
Management Written Representations
The auditor shall obtain written representations from
management that:
1. It acknowledges its responsibility for internal control to
prevent and detect fraud;
2. It has disclosed to the auditor:
• the results of its assessment of the risk that the
financial statements may be materially misstated
due to fraud;
• its knowledge or suspicion of fraud involving:
management; employees who have significant roles
in internal control; or others where the fraud could
have a material effect on the financial statements;
and
• 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.
Auditor Unable to Continue the Engagement
Examples of these exceptional circumstances include:
• The entity does not take the appropriate action
regarding fraud that the auditor considers necessary,
even when the fraud is not material to the financial
statements;
• The auditor’s consideration of the risk of material
misstatement due to fraud and the results of audit tests
indicate a significant risk of material and pervasive
fraud; or
• The auditor has significant concern about the
competence or integrity of management or TCWG.
If, as a result of circumstances, the auditor shall:
1. Consider whether it is appropriate to withdraw from the
engagement; and
2. If the auditor withdraws:
• Discuss with the appropriate level of management
and TCWG, including the reasons thereof; and
• Determine whether there is a professional or legal
requirement to report to the person or persons or,
in some cases, to regulatory authorities.
Documentation
The auditor’s documentation shall include the:
1. Significant decisions reached during ‘brainstorming’
regarding the susceptibility of the entity’s financial
statements to material misstatement due to fraud;
2. Identified and assessed risk of material misstatement
due to fraud at the financial statements level and at the
assertion level.
3. Responses to the assessed risk of material
misstatements: the overall responses and the nature,
timing and extent of further audit procedures;
4. Results of the audit procedures;
Page 4 of 10 www.teamprtc.com.ph
5. Communications about fraud made to management,
TCWG, regulators and others; and
6. Reasons for that conclusion risk of material
misstatement due to fraud related to revenue
recognition is not applicable.
Auditor’s Responsibility to Consider Laws and
Regulations
Introduction
The auditor needs to consider the applicable laws and
regulations to the entity in financial statements audit
because compliance and non-compliance with those laws
and regulations affect the financial statements in many
ways. In addition, those laws and regulations to which an
entity is subject constitute the legal and regulatory
framework in which the entity operates.
Nature and Definition of Non-compliance
Non-compliance refers to acts of omission or commission by
the entity (intentional or unintentional), which are contrary
to the prevailing laws or regulations. Such acts include
transactions entered into by, or in the name of, the entity,
or on its behalf, by TCWG, management or
employees. However, non-compliance does not include
personal misconduct (unrelated to the business activities of
the entity) by TCWG, management or employees of the
entity.
Types of Laws and Regulations
In relation to financial statements, there are two types:
1. Direct effect–Amounts and disclosures, as a result of
compliance, are reported on the financial statements
such as tax and pension laws and regulations
2. Indirect effect–Relates primarily to operations of the
entity but does not have a direct effect on an entity’s
financial statements. However non-compliance may
result in fines, litigation or other consequences for the
entity that may have a material effect on the financial
statements. Examples may include compliance with the
terms of an operating license, regulatory solvency
requirements, or environmental regulations.
Responsibility for Compliance with Laws and
Regulations
Responsibility of Management for Compliance with Laws and
Regulations
Management, with the oversight of TCWG, is responsible for
ensuring that the entity’s operations are conducted in
accordance with laws and regulations.
Responsibility of the Auditor
The auditor is responsible for obtaining reasonable
assurance that the financial statements, taken as a whole,
are free from material misstatement, whether caused by
fraud or error.
The auditor shall identify ROMM of the financial statements
due to non-compliance with laws and regulations. However,
the auditor is not responsible for preventing non-compliance
and cannot be expected to detect non-compliance with all
laws and regulations. In the absence of evidence to the
contrary, the auditor is entitled to assume the entity is in
AT.3215
EXCEL PROFESSIONAL SERVICES, INC.

compliance with applicable laws and regulations affecting performing substantive tests of details of classes of
the client transactions, account balances or disclosures.

In the context of laws and regulations, the potential effects
of inherent limitations on the auditor’s ability to detect
material misstatements are greater because:
• Many laws and regulations, relating principally to the
operating aspects of an entity, do not affect the financial
statements.
• Non-compliance may be concealed, management
override of controls or intentional misrepresentations to
the auditor.
• Whether an act constitutes non-compliance is ultimately
determined by a court of law.
Ordinarily, the further removed non-compliance is from the
events and transactions reflected in the financial
statements, the less likely the auditor is to become aware
of it or to recognize the non-compliance.
The Auditor’s Consideration of Compliance with Laws
and Regulations
Written Representations
The auditor shall request management and, where
appropriate, TCWG to provide written representations that
all known instances of non-compliance or suspected non-
compliance with laws and regulations whose effects should
be considered when preparing financial statements have
been disclosed.
No Identified or Suspected Non-compliance
In the absence of identified or suspected non-compliance,
the auditor is not required to perform audit procedures
regarding the entity’s compliance with laws and regulations,
other than those set out above.
Audit Procedures When Non-Compliance Is Identified
or Suspected
The auditor shall obtain:

Obtaining an Understanding of the Legal and Regulatory
Framework
As part of obtaining an understanding of the entity and its
environment, the auditor shall obtain a general
understanding of:
1. An understanding of the nature of the act and the
circumstances in which it has occurred; and
2. Further information to evaluate the possible effect on
the financial statements

1. The legal and regulatory framework applicable to the

entity and the industry or sector in which the entity
operates; and
2. How the entity is complying with that framework.

Direct Effect Laws and Regulations

The auditor shall obtain sufficient appropriate audit

evidence regarding compliance with the provisions of those
laws and regulations with direct effect on the material
amounts and disclosures in the financial statements.

Indirect Effect Laws and Regulations

The auditor shall perform the following to identify non-

compliance that may have a material effect on the financial
statements:

1. Inquiry of management and, where appropriate, TCWG,

as to whether the entity is in compliance with such laws
and regulations; and
2. Inspection of correspondence, if any, with the relevant
licensing or regulatory authorities.

Non-Compliance Brought to the Auditor’s Attention by Other

Audit Procedures

During the audit, the auditor shall remain alert to the

possibility that other audit procedures applied may bring
instances of non-compliance or suspected non-compliance
with laws and regulations to the auditor’s attention.

Audit procedures applied to form an opinion on the financial

statements may bring instances of non-compliance or
suspected non-compliance with laws and regulations to the
auditor’s attention. For example, such audit procedures may
include: reading minutes; inquiring of the entity’s
management and in-house legal counsel or external legal
counsel concerning litigation, claims and assessments; and

Page 5 of 10 www.teamprtc.com.ph AT.3215

EXCEL PROFESSIONAL SERVICES, INC.
Summary of Auditor’s Responsibility for Fraud, Error and Non-compliance with Laws and Regulations
Errors
Unintentional
Definition misstatements or
omissions
Mistake in processing
accounting data, incorrect
accounting estimates due
Examples
to oversight, mistakes in
application of accounting
principles
1. Assessment of ROMM.
2. Based on assessment,
design audit to
provide reasonable
assurance of detection
of material
misstatements.
Detection
3. Exercise due care in
responsi-
planning, performing,
bility
and evaluating results
of audit procedures,
and proper degree of
professional
skepticism to achieve
reasonable assurance
of detection.
Reporting Modify auditor’s reports
responsi- for material misstatement
bility or inability to obtain SAAE
DISCUSSION QUESTIONS
Fraud and Error
Fraud vs. Error
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.
Page 6 of 10
Non-compliance with laws & regulations
Fraud Direct effect Indirect effect
Relate primarily to entity’s
operations but does not
Amounts and
have a direct effect on an
disclosures, as a
entity’s financial
Intentional result of
statements. Non-
misstatements or compliance, are
compliance may result in
omissions reported on the
fines, litigation or other
financial
consequences that may
statements
have a material effect on
the financial statements.
Two types—fraudulent
financial reporting
(falsification of Terms of an operating
Tax and pension
accounting records) license, regulatory
laws and
and misappropriation solvency requirements, or
regulations
of assets environmental regulations.
(embezzlement or
theft)
1. Be aware of possibility
that they may have
occurred.
2. Inquire of
management and
TCWG regarding
compliance.
3. Inspect
correspondence with
regulatory authorities
(Same as for
(Same as for errors) 4. 4. If specific
errors)
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.
(Same as for
(Same as for errors) (Same as for errors)
errors)
- done -
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
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.
www.teamprtc.com.ph AT.3215
EXCEL PROFESSIONAL SERVICES, INC.
Types of 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
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
Responsibilities for Fraud
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
Page 7 of 10 www.teamprtc.com.ph
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.
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.
Auditor's Fraud Consideration
Risk Assessment Procedures
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.
Engagement Team Discussion (‘Brainstorming’)
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.
AT.3215
EXCEL PROFESSIONAL SERVICES, INC.

14. Which of the following issues is normally part of the a. Capitalization of repairs and maintenance into the
“brainstorming” session required by PSAs? property, plant, and equipment asset account.
a. b. c. d. b. Improper revenue recognition.
How assets could be c. Improper interest expense accrual.
misappropriated Yes Yes Yes No d. Introduction of significant new products.
How and where the entity’s
financial statements are Responding to Assessed ROMM due to fraud
susceptible to material
misstatements due to Yes Yes Yes Yes 20. Statement 1: Auditors are required to perform
fraud extended audit procedures to detect material errors and
The need for professional irregularities if previously performed examinations
skepticism Yes No No Yes indicate that they may exist.
The audit team’s response to
potential fraud risks Yes Yes No No Statement 2: Audit procedures that are effective for
detecting an unintentional misstatement may be
Identifying and Assessing the ROMM due to Fraud ineffective for an intentional misstatement that is
concealed through collusion.
15. The fraud triangle consists of three components a. True, true c. False, true
(incentive or pressure, opportunity, and attitude or b. True, false d. False, false
rationalization). Which of the three components are
present in most every fraud? 21. Which of the following is most likely to be an overall
a. All three factors are usually present when fraud response to fraud risks identified in an audit?
occurs. a. Supervise members of the audit team less closely
b. Pressure and opportunity and rely more upon judgment.
c. Opportunity and rationalization b. Only use certified public accountants on the
d. Rationalization and pressure engagement.
c. Place increased emphasis on the audit of objective
16. Categories of fraud risk factors (whose presence often transactions rather than subjective transactions.
has been observed in circumstances where frauds have d. Use less predictable audit procedures.
occurred) in relation to misstatements arising from
misappropriation of assets and fraudulent financial 22. Which of the following is most likely to be a response to
reporting are opportunities, attitudes or the auditor's assessment that the risk of material
rationalizations, and pressures or incentives. Which of misstatement due to fraud for the existence of inventory
the following creates an opportunity for fraud to be is high?
committed in an organization? a. Observe test counts of inventory at certain locations
a. Management demands financial success or is on an unannounced basis.
aggressive in its application of accounting rules. b. Perform analytical procedures rather than taking
b. Poor internal control. test counts.
c. Commitments tied to debt covenants. c. Request that inventories be counted prior to year-
d. Finding loopholes in the accounting rules to achieve end.
earnings targets. d. Request that inventory counts at the various
locations be counted on different dates so as to
17. The following are examples of circumstances that may allow the same auditor to be present at every count.
indicate the possibility that the financial statements
may contain a material misstatement resulting from 23. As part of designing and performing procedures to
fraud, except address management override of controls, auditors
a. Transactions that are recorded in a complete or must perform which of the following procedures?
timely manner or are properly recorded as to a. b. c. d.
amount, accounting period, classification, or entity Review accounting estimates
policy. for biases Yes Yes Yes No
b. Unsupported or unauthorized balances or Examine all journal entries
transactions. above materiality Yes No Yes Yes
c. Last-minute adjustments that significantly affect Examine adjusting entries Yes Yes No Yes
financial results or unusual journal entries. Review unusual transactions Yes Yes No No
d. Tips or complaints to the auditor about alleged
fraud. Conclusion and Reporting

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?
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:

Page 8 of 10 www.teamprtc.com.ph AT.3215

EXCEL PROFESSIONAL SERVICES, INC.
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.
Withdrawing from Engagement Because 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
charged with governance that affect the auditor's
ability to rely on management's representations.
d. All of the above
Noncompliance with Laws and Regulations
Definition
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.
Effect of Laws and Regulations on Financial Statements
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.
Page 9 of 10 www.teamprtc.com.ph
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 indirect-
effect illegal acts is similar to the responsibility to
detect fraud.
d. The auditor’s responsibility for detecting direct-
effect illegal acts is similar to the responsibility to
detect fraud.
Responsibility for Compliance with Laws and Regulations
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.
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.
The Auditor’s Consideration of Compliance with Laws and
Regulations
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.
AT.3215
EXCEL PROFESSIONAL SERVICES, INC.

d. Neither a nor b.
38. In assessing whether management has overlooked
34. According to PSA 250 (Consideration of Laws and relevant laws and regulations, the auditor would
Regulations in an Audit of Financial Statements), the perform all of the following except
following are indications that noncompliance may have a. Obtain written representations from management.
occurred, except b. Review relevant portions of grant and loan
a. Investigation by government departments or agreements.
payment of fines or penalties c. Confirm grant arrangements with granting
b. Adverse media comment agencies.
c. Authorized transactions or properly recorded d. Discuss laws and regulations with the entity's chief
transactions financial officer and legal counsel.
d. Purchasing at prices significantly above or below
market price 39. When an auditor becomes aware of a possible illegal act
by a client, the auditor should obtain an understanding
35. Examples of the type of information that may come to of the nature of the act to
the auditor's attention that may indicate that a. Increase the assessed level of control risk.
noncompliance with laws or regulations has occurred b. Recommend remedial actions to the audit
least likely include committee.
a. Payments for unspecified services or loans to c. Determine the reliability of management’s
consultants, related parties, employees or representations.
government employees. d. Evaluate the effect on the financial statements and
b. Payments for goods or services made other than to may consider seeking legal advice especially when
the country from which the goods or services involving members of senior management,
originated. including members of the board of directors.
c. Unauthorized transactions or improperly recorded
transactions. 40. Which of the following is the auditor least likely to do
d. Payments with proper exchange control when aware of an illegal act?
documentation. a. Discuss the matter with the client’s legal counsel.
b. Obtain evidence about the potential effect of the
36. When an auditor identifies or suspects instances of non- illegal act on the financial statements.
compliance with laws and regulations in relation to audit c. Consider the impact of the illegal act on the
of financial statements, the auditor shall relationship with the company’s management.
a. b. c. d. d. Contact the local law enforcement officials
Obtain understanding of the regarding potential criminal wrongdoing.
nature of the act. Yes Yes Yes No
Evaluate possible effect of End of AT.3215
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

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.

Page 10 of 10 www.teamprtc.com.ph AT.3215