Tutorial: Auditor’s Responsibilities and Liability &

Fraud and Errors

Multiple Choice Questions – Choose the best answer for each question.

1. Which of the auditor’s four defenses is ordinarily not available in third-party

lawsuits?

A. Absence of causal connections

B. Non-negligent performance
C. Contributory negligence
D. Lack of duty

2. Which of the following responsibilities rests with the management of an entity?

(i) Selecting and adopting the appropriate accounting policies.

(ii) Ensuring the financial statements of the entity are fairly presented.
(iii) Preparing sustainability reports.
(iv) Establishing and maintaining an effective internal control system.

A. (ii) and (iv)

B. (i), (ii) and (iv)
C. (i), (iii) and (iv)
D. (i) and (ii)

3. Which of the following is NOT one of auditors’ responsibilities in verifying

financial statements?

A. To discharge properly the statutory duty to report on the true and fair view
of financial statements.
B. To ensure that independence is not impaired.
C. To comply with the fundamental principles of integrity, objectivity,
professional competence and due care, confidentiality and professional
behaviour.

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D. To prepare audited financial statements for shareholders in accordance
with the applicable financial reporting framework

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4. In which of the following ways can professional skepticism be described?

(i) It refers to an attitude that includes a questioning mind.

(ii) It involves the making of informed decisions about the courses of action
that are appropriate in the circumstances of the audit engagement.
(iii) It is being alert to conditions that may indicate possible misstatement due
to error or fraud.
(iv) It involves a critical assessment of audit evidence.
(v) It refers to the consideration of events or conditions that indicate an
incentive or pressure to commit fraud or provide an opportunity to
commit fraud.

A. (i), (iii) and (v)

B. (i), (ii) and (iv)
C. (ii), (iv) and (v)
D. (ii), (iii) and (v)

5. The new Companies Ordinance requires auditors:

(i) To conduct investigations to ensure the true and fair view of the financial
statements.
(ii) To obtain the necessary information and explanations for audit purposes.
(iii) To report on the truth and fairness of client’s financial statements.
(iv) To attend all general meetings on client’s business.
(v) To prepare written representation on matters that are noteworthy to the
members concerning their resignation and removal.

A. (i), (ii) and (iv)

B. (ii), (iv) and (v)
C. (ii), (iii) and (v)
D. All of the above

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6. In which of the following circumstances would the independence of the CPA be
impaired?

(i) The CPA represents to a potential client that the CPA’s fees are
substantially lower than the fees charged by other CPA comparable
services.
(ii) The CPA has a direct financial interest in an audit client, but the interest is
maintained in a trust.
(iii) The CPA provides additional professional services to an audit client and the
income for the additional services is material to the CPA.

A. (i) and (iii)

B. (ii) and (iii)
C. (ii) and (iv)
D. All of the above

7. Which of the following is least likely an example of fraudulent financial

reporting?

A. An employee steals inventory, and the shortage is covered up by included it

as part of the cost of goods sold.
B. Company management falsifies inventory count tags for the purpose of
overstatement of inventory closing balance.
C. An employee borrows loose tools from the store of the company and
subsequently forgets to return it.
D. A staff diverts customer payments to his personal use and the concealing
this by writing off the related accounts receivable.

8. The person who bears primary responsibility for preventing fraud in an

organisation is

A. Audit committee established by the board of directors of the company

B. Internal auditor of the company
C. External auditor of the company
D. Management of the company

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Short-Essay Questions

1. During the audit of Bella Beauty Limited, you were assigned to perform the audit
procedures as required in International Standards on Auditing: “The Auditor’s
Responsibilities Relating to Fraud in an Audit of Financial Statements” and have
found the following:

• A sales invoice amounting to $567,000 was incorrectly prepared as $576,000

due to a transposition error committed by the billing clerk.
• Salaries of the company staff were paid through autopay. For two
consecutive months, the bank autopay instructions included the payroll of a
terminated manager who had left the company two months before.
• An accounts clerk, who was also responsible for recording cash receipts and
debtors, stole the cash receipts of $150,000 from a debtor. It was found that
these stolen receipts have not been recorded in the debtor’s sub-ledger.
• An underestimation of allowance for doubtful accounts $2,000,000 arising
from the misinterpretation of information.
• Intentional misapplication of accounting standards relating to capitalisation
of expenditure as asset for $3,000,000.

Required:
(a) Distinguish between fraud and error.
(b) Who has the primary responsibility for the prevention and detection of
fraud and error?
(c) Give FIVE examples of fraud risk factors.
(d) Referring to the above misstatements, state whether the misstatement
constitutes a fraud or an error.
(e) Discuss the actions to be taken by auditors if they have identified a fraud.

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2. External auditors will be liable to the client as well as the third party who have
relied on the financial statements upon which they expressed an opinion.
Therefore, it is necessary for external auditors to exercise professional care when
carrying out audit services. However, there is no general standard for the
expected level of skill and care required for carrying out an audit assignment.

Required:
(a) How can the external auditor maintain a reasonable standard of
professional care?
(b) Describe how the auditor’s professional liability of negligence to the
client and to the third party can be established under common law.
(c) In relation to the quality control at both the firm and engagement levels,
provide examples of the measures external auditors may take to reduce
their professional liability.