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

Since 1977
AT.3507
Considering the Risk of Frauds, Errors SOLIMAN/UY/AGUILA/RICAFRENTE
and Non-compliance with Laws and Regulations October 2023

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 risk of
material misstatement.
2. Based on assessment,
design audit to provide
reasonable assurance
of detection of material
Detection misstatements.
responsi- 3. Exercise due care in
bility planning, performing,
and evaluating results
of audit procedures,
and proper degree of
professional skepticism
to achieve reasonable
assurance of detection.
Modify auditor’s reports for
Reporting material misstatement or
responsi- inability to obtain sufficient
bility and appropriate audit
evidence.
Non-compliance with laws & regulations
Fraud Direct effect Indirect effect
Relate primarily to entity’s
Amounts and operations but does not have
disclosures, as a a direct effect on an entity’s
Intentional result of financial statements. Non-
misstatements or compliance, are compliance may result in
omissions reported on the fines, litigation or other
financial consequences that may have
statements a material effect on the
financial statements.
Two types—
fraudulent financial
reporting
(falsification of Terms of an operating license,
Tax and pension
accounting records) regulatory solvency
laws and
and requirements, or
regulations
misappropriation of environmental regulations.
assets
(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 information
errors)
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)

1. What differentiates fraud from an error? detecting a material misstatement resulting from error
a. Materiality. because
b. Effect on misstatements. a. The effect of fraudulent act is likely omitted in the
c. Intent. accounting records.
d. Frequency of occurrence. b. Fraud is ordinarily accompanied by acts specifically
designed to conceal its existence, and auditors do
2. The following are examples of error, except not make legal determinations of whether fraud has
a. A mistake in gathering or processing data from actually occurred.
which financial statements are prepared. c. Fraud is always a result of connivance between or
b. An incorrect accounting estimate arising from among employees.
oversight or misinterpretation of facts. d. The auditor is responsible to detect errors but not
c. A mistake in the application of accounting principles fraud.
relating to measurement, recognition, classification,
presentation, or disclosure. 4. The two types of intentional misstatements that are
d. Misrepresentation in the financial statements of relevant to the auditor’s consideration of fraud include,
events, transaction or other significant information. misstatements resulting from fraudulent financial
reporting and misstatements resulting from
3. The risk of not detecting a material misstatement misappropriation of assets. Fraudulent financial
resulting from fraud is higher than the risk of not 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 year-
end.
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.
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

28. Which of the following would most likely be deemed a audit of financial statements, an auditor shall
direct-effect illegal act? a. Inquire of management and those charged with
a. Violation of employment laws. governance.
b. Violation of environmental regulations. b. Inspect correspondences with regulatory
c. Violation of income tax laws. authorities.
d. Violation of civil rights laws. c. Both a and b.
d. Neither a nor b.
29. Which of the following illegal acts should an audit be
designed to obtain reasonable assurance of detecting? 34. According to PSA 250 (Consideration of Laws and
a. Securities purchased by relatives of management Regulations in an Audit of Financial Statements), the
based on knowledge of inside information. following are indications that noncompliance may have
b. Accrual and billing of an improper amount of occurred, except
revenue under government contracts. a. Investigation by government departments or
c. Violations of antitrust laws. payment of fines or penalties
d. Price fixing. b. Adverse media comment
c. Authorized transactions or properly recorded
30. Which of the following statements is usually true? transactions
a. It is easier for the auditor to uncover fraud than d. Purchasing at prices significantly above or below
errors. market price
b. It is easier for the auditor to uncover indirect-effect
illegal acts than fraud. 35. Examples of the type of information that may come to
c. The auditor’s responsibility for detecting indirect- the auditor's attention that may indicate that
effect illegal acts is similar to the responsibility to noncompliance with laws or regulations has occurred
detect fraud. least likely include
d. The auditor’s responsibility for detecting direct- a. Payments for unspecified services or loans to
effect illegal acts is similar to the responsibility to consultants, related parties, employees or
detect fraud. government employees.
b. Payments for goods or services made other than to
31. Which of the following is incorrect about the auditor’s the country from which the goods or services
responsibility for evaluating noncompliance by the originated.
entity to laws and regulations? c. Unauthorized transactions or improperly recorded
a. It is the responsibility of management, with the transactions.
oversight of those charged with governance, to d. Payments with proper exchange control
ensure that the entity’s operations are conducted in documentation.
accordance with laws and regulations, including
compliance with laws and regulations that 36. When an auditor identifies or suspects instances of non-
determine the form or content of the entity’s compliance with laws and regulations in relation to audit
financial statements. This includes responsibility for of financial statements, the auditor shall
the prevention and detection of non-compliance a. b. c. d.
with laws and regulations. Obtain understanding of the
b. An audit cannot be expected to detect nature of the act. Yes Yes Yes No
noncompliance with all laws and regulations. Evaluate possible effect of
Detection of noncompliance, regardless of noncompliance on financial
materiality, requires considerations of the statements. Yes No Yes Yes
implications for the integrity of management or Discuss the matter with
employees management and TCWG. Yes Yes No Yes
c. Generally, the further removed non-compliance is Consider obtaining legal Yes Yes No No
from the events and transactions reflected in the advice.
financial statements, the more likely the auditor is Evaluate other audit
to become aware of it or to recognize the possible implications. Yes Yes No No
non-compliance. This is because an illegal act by the
client often relate to operating aspects rather than
accounting aspects.

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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.

***End***

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