AUDITING THEORY
AT.0105-The Auditor’s Responsibilities Relating to Fraud, Error and Non-compliance
LECTURE NOTES
Auditor's Responsibilities Relating to Fraud and
Error
Introduction
The auditor is responsible for obtaining reasonable
assurance that the FSs taken as a whole are free from
material misstatement, whether caused by fraud or error.
Hence, the auditor’s responsibility for the detection of
fraud and error is essentially the same.
Fraud refers to an intentional act by one or more
individuals among management, TCWG, employees, or
third parties, involving the use of deception to obtain an
unjust or illegal advantage. While, error pertains to
unintentional misstatements or omissions in FSs, including
the omission of an amount or disclosure. Differentiating
fraud from error requires professional judgment. The risk
of not fraud is higher than error because fraud may be
concealed, especially if through collusion.
Although fraud is a broad legal concept, the auditor is
concerned with fraud that causes a material misstatement
in the FSs. In addition, the auditor does not make legal
determinations of whether fraud has actually occurred.
Types of Fraud
In relation to audit of financial statements:
a. Fraudulent financial reporting – Involves intentional
misstatements, including omissions of amounts or
disclosures in FSs, to deceive FS users, normally
involves management. Examples are the following:
 Manipulation or falsification of financial records
 Misrepresentation or intentional omission
of information in the FSs
 Intentional misapplication of accounting policies
b. Misappropriation of assets (theft) - Involves the theft
of an entity’s assets and is often perpetrated by
employees in relatively small and immaterial
amounts. However, it can also involve management
and TCWG. Examples of this type of fraud are the
following:
 Embezzling receipts
 Lapping of accounts receivable
 Entity funds sent to a personal bank account
 Inventory items sold personally by entity
employees
 Goods or services paid for by the entity but
not received
 Use of entity assets for personal use
As to perpetrator:
a. Management fraud – refers to fraud involving one or
more members of management or TCWG.
b. Employee fraud – refers to fraud involving only
employees of the entity.
The risk of the auditor not detecting management fraud is
greater than for employee fraud, because management
may override otherwise effective internal controls.
Responsibility of Management and Those Charged
with Governance (TCWG) vs. that of the Auditor
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The primary responsibility for the prevention and detection
of fraud rests with both TCWG of the entity and
management. Management shall establish a control
environment and implement internal control policies and
procedures to prevent and detect fraud. On the other
hand, TCWG, through its oversight function, shall ensure
the integrity of accounting and financial reporting systems
and that appropriate controls are in place.
On the other hand, the auditor’s responsibility is to obtain
reasonable assurance about whether the FSs taken as a
whole are free from material misstatement, whether
caused by fraud or error. The auditor is not responsible
for discovering fraud, and is not and cannot be held
responsible for the prevention of fraud. Unless the auditor
has reason to believe the contrary, the auditor may accept
records and documents as genuine. An audit rarely
involves the authentication of documents.
The auditor shall perform the procedures below following
the risk-based audit process:
 maintaining an attitude of professional skepticism;
 exercising professional judgment;
 holding engagement team discussion (‘brainstorming’);
 performing RAP and related activities;
 identifying and assessing the ROMM due to fraud;
 responding to assessed ROMM due to fraud;
 evaluating the audit evidence and the results of audit;
 communicating misstatements resulting from fraud;
 obtaining management representations;
 considering withdrawing from engagement; and
 documenting the results of work.
Discussion Among the Engagement Team
This discussion shall place particular emphasis on how and
where the entity’s FSs 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.
Performing 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.
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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 ROMM due to fraud.
Other Information
The auditor shall consider whether other information
obtained by the auditor indicates 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. The three
conditions (the fraud triangle or characteristics) generally
present when fraud occurs are:
a) 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.
b) 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.
c) 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.
Identifying and Assessing the ROMM Due to Fraud
The auditor shall identify and assess the ROMM due to
fraud at the FSs level, and at the assertion level for classes
of transactions, account balances and disclosures.
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.
Understanding the Entity’s Related Controls
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 ROMM due to fraud at the FSs level.
Audit Procedures Responsive to Assessed Risks of Material
Misstatement Due to Fraud at the Assertion Level
The auditor shall design and perform FAP whose nature,
timing and extent are responsive to the assessed ROMM
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 FSs by overriding controls
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that otherwise appears to be operating effectively. Due to
the unpredictable way in which such override could occur,
it is a ROMM 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:
a. Test the journal entries and other adjustments made in
the preparation of the FSs.
b. Review accounting estimates for biases.
c. 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 ROMM 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 FSs as a whole are consistent with the
auditor’s understanding of the entity and its environment
indicate a previously unrecognized ROMM 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:
o Refer to appropriate level of management (one
level above the person involved)
o Gain satisfaction no FSs effect
 If material or unable to evaluate whether material
or immaterial:
o Consider implications for audit, e.g., reliability of
management representations
o Investigate further, i.e., discuss with appropriate
level of management (one level above the person
involved)
o Obtain evidence of fraud and its effects
o 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 FSs, the auditor reports
such matters on a timely basis and may consider it
necessary to also report such matters in writing.
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In some cases, the auditor may consider it appropriate to material misstatement due to fraud;
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 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.

Communication of Misstatements due to Error

The auditor should communicate to management (and to
TCWG, where necessary) any identified material
misstatements resulting from error. In addition, the
auditor should communicate also to TCWG those
uncorrected misstatements aggregated by the auditor
during the audit that were deemed by management as
immaterial to the FSs.
Management Written Representations
The auditor shall obtain written representations from
management that:
a. It acknowledges its responsibility for internal control
to prevent and detect fraud;
b. It has disclosed to the auditor:
 the results of its assessment of the risk that
the FSs 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 FSs; and
 its knowledge of any allegations of fraud,
or suspected fraud, affecting the entity’s
FSs
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 FSs;
 The auditor’s consideration of the ROMM 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:
a) Consider whether it is appropriate to withdraw from
the engagement; and
b) 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:
a) Significant decisions reached during ‘brainstorming’
regarding the susceptibility of the entity’s FSs to

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b) Identified and assessed ROMM due to fraud at the detect material misstatements are greater because:
FSs level and at the assertion level.  Many laws and regulations, relating principally to the
c) Responses to the assessed ROMM: the overall operating aspects of an entity, do not affect the FSs.
responses and the nature, timing and extent of
FAP;
d) Results of the audit procedures;
e) Communications about fraud made to management,
TCWG, regulators and others; and
f) Reasons for that conclusion ROMM 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 FSs audit because
compliance and non-compliance with those laws and
regulations affect the FSs 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–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 audit of FSs, there are two types:
a. Direct effect–Amounts and disclosures, as a result
of compliance, are reported on the FSs such as
tax and pension laws and regulations
b. Indirect effect–Relates primarily to operations of the
entity but does not have a direct effect on an
entity’s FSs. However non-compliance may result in
fines, litigation or other consequences for the entity
that may have a material effect on the FSs.
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 FSs, taken as a whole, are free from
material misstatement, whether caused by fraud or
error.
The auditor shall identify ROMM of the FSs 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 compliance with applicable laws and regulations
affecting the client
In the context of laws and regulations, the potential
effects of inherent limitations on the auditor’s ability to
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 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 FSs, 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
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:
a) The legal and regulatory framework applicable to the
entity and the industry or sector in which the entity
operates; and
b) 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 FSs.
Indirect Effect Laws and Regulations
The auditor shall perform the following to identify non-
compliance that may have a material effect on the FSs:
a. Inquiring of management and, where appropriate,
TCWG, as to whether the entity is in compliance
with such laws and regulations; and
b. Inspecting 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 FSs
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 performing substantive tests of details of classes of
transactions, account balances or disclosures.
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 FSs 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:
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a) An understanding of the nature of the act and the
circumstances in which it has occurred; and
b) Further information to evaluate the possible effect on
the FSs.
Audit Procedures
If the auditor suspects there may be non-compliance, the
auditor shall discuss the matter with management and,
where appropriate, TCWG. If management or, as
appropriate, TCWG do not provide sufficient information
that supports that the entity is in compliance with laws
and regulations and, in the auditor’s judgment, the effect
of the suspected non-compliance may be material to the
FSs, the auditor shall consider the need to obtain legal
advice.
Evaluating the Implications of Non-Compliance
The auditor shall evaluate the implications of non-
compliance in relation to other aspects of the audit,
including the auditor’s risk assessment and the reliability
of written representations, and take appropriate action.
In exceptional cases, the auditor may consider whether,
unless prohibited by law or regulation, withdrawal from
the engagement is necessary when management or TCWG
do not take the necessary remedial action, even when the
non-compliance is not material but the auditor may
consider seeking legal advice. If withdrawal is prohibited,
the auditor may consider alternative actions, including
describing the non-compliance in an Other Matter(s)
paragraph in the auditor’s report.
Reporting of Identified or Suspected Non-
Compliance
Reporting to Those Charged with Governance
The auditor shall communicate to TCWG matters involving
non-compliance with laws and regulations, unless those
are clearly inconsequential and they are involved in
management and already aware of it.
If the auditor suspects that management or TCWG is
involved in non-compliance, communicate the matter to
the next higher level of authority at the entity, if it exists.
Otherwise consider obtaining legal advice.
Reporting in the Auditor’s Report
Results Opinion
No sufficient appropriate audit
evidence obtained as precluded by Qualified or
management or TCWG Disclaimer
No sufficient appropriate audit
evidence obtained imposed by Evaluate effect on
circumstances audit report
Contains material misstatement Qualified or Adverse
Reporting to Regulatory and Enforcement Authorities
If the auditor has identified or suspects non-compliance
with laws and regulations, determine whether the
auditor has a responsibility to report the identified or
suspected non-compliance to parties outside the entity.
The auditor’s professional duty to maintain the
confidentiality of client information may preclude reporting
identified or suspected non-compliance with laws and
regulations to a party outside the entity.
Documentation
The auditor shall document identified or suspected non-
compliance with laws and regulations and the results of
discussion with management and, where applicable, TCWG
and other parties outside the entity. For example: copies
of records or documents or minutes of discussions held
with management, TCWG or parties outside the entity.
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 MULTIPLE CHOICE
Fraud and Error
c. Theft of assets covered up by manipulation of
Fraud vs. Error
accounting records
1. What is the primary determinate in the
d. Agreement between two or more persons to
difference between fraud and errors?
commit a criminal act
a. The materiality of the misstatement.
b. The intent to deceive. 7. The most difficult type of misstatement to detect is
c. The level of management involved. fraud based on
d. The type of transaction effected. a. The overrecording of transactions.
b. The nonrecording of transactions.
2. The following are examples of error, except
c. Recorded transactions in subsidiaries or incorrect
a. A mistake in gathering or processing data from
postings of recorded transactions.
which financial statements are prepared.
d. Related-party receivables.
b. An incorrect accounting estimate arising from
oversight or misinterpretation of facts Responsibilities for fraud
c. A mistake in the application of accounting 8. Which statement(s) is(are) incorrect regarding the
principles relating to measurement, recognition, auditor’s responsibility to consider fraud and error in
classification, presentation, or disclosure an audit of financial statements?
d. Misrepresentation in the financial statements of a. The auditor is not and cannot be held responsible
events, transaction or other significant information for the prevention of fraud and error being the
primary responsibility of both the management
3. The risk of not detecting a material misstatement
and those charged with governance.
resulting from fraud is higher than the risk of not
b. When planning and performing audit procedures
detecting a material misstatement resulting from error
and evaluating and reporting the results thereof,
because
the auditor should consider the risk of
a. The effect of fraudulent act is likely omitted in the
misstatements in the financial statements resulting
accounting records
from fraud.
b. Fraud is ordinarily accompanied by acts specifically
c. In planning the audit, the auditor should discuss
designed to conceal its existence and auditors do
with other members of the audit team the
not make legal determinations of whether fraud
susceptibility of the entity to material statements
has actually occurred
in the financial statements resulting from fraud or
c. Fraud is always a result of connivance between or
error and exercise professional skepticism (the
among employees
best method to detect fraud).
d. The auditor is responsible to detect errors but not
d. The auditor should design audit programs that will
fraud
provide reasonable assurance that material errors
Types of fraud and fraud will be detected in the ordinary course of
4. The two types of intentional misstatements that are the examination.
relevant to the auditor’s consideration of fraud include,
Engagement Team Discussion (‘Brainstorming’)
misstatements resulting from fraudulent financial
9. Brainstorming about the susceptibility of the entity’s
reporting and misstatements resulting from
financial statements to material misstatement due to
misappropriation of assets. Fraudulent financial
fraud include the following advantages?
reporting least likely involve
a. Provides an opportunity for more experienced
a. Deception such as manipulation, falsification
engagement team members to share their insights
(including forgery), or alteration of accounting
about how and where the FSs may be susceptible
records or supporting documents from which the
to material misstatement due to fraud and how
financial statements are prepared
entity’s assets could be misappropriated
b. Misrepresentation in, or intentional omission from,
b. Enables the auditor to consider an appropriate
the financial statements of events, transaction or
response to such susceptibility and to determine
other significant information
which members of the engagement team will
c. Intentional misapplication of accounting principles
conduct certain audit procedures.
relating to measurement, recognition,
c. Permits the auditor to determine how the results
classification, presentation, or disclosure
of audit procedures will be shared among the
d. Embezzling receipts, stealing physical assets or
engagement team and how to deal with any
intellectual property , causing an entity to pay for
allegations of fraud that may come to the auditor’s
goods and services not received, or using an
attention.
entity’s assets for personal use.
d. All of the above.
5. In comparing management fraud with employee fraud,
Risk Assessment Procedures and Related Activities
the auditor’s risk of failing to discover the fraud is
10. Sources of information gathered to assess fraud risks
a. Greater for employee fraud because of the higher
usually do not include:
crime rate among blue collar workers
a. Analytical procedures.
b. Greater for management fraud because of
b. Inquiries of management and others within the
management’s ability to override existing internal
entity.
controls, which is always assumed in audit.
c. Communication among audit team members.
c. Greater for employee fraud because of the larger
d. Review of corporate charter and bylaws.
number of employees in the organization
d. Greater for management fraud because managers 11. Categories of fraud risk factors (whose presence often
are inherently smarter than employees has been observed in circumstances where frauds have
occurred) in relation to misstatements arising from
6. Which of the following constitutes the fraud of larceny?
misappropriation of assets and fraudulent financial
a. Misappropriation of assets that have been
reporting are: opportunities; attitudes or
entrusted to one’s care
rationalizations; and pressures or incentives. Which of
b. Theft of assets

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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.
Identifying and Assessing the ROMM due to fraud
12. Which of the following is an example of a common type
of financial reporting fraud?
a. Capitalizing major overhauls to operating
equipment.
b. Deferring service revenue until it is delivered to
customers.
c. Recording sales for inventory sold with the right to
return, hence, fraud on revenue recognition is
always presumed to exist in absence or conditions
to the contrary.
d. Excluding a contingent liability that has
been settled.
Responding to Assessed ROMM due to fraud
13. 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. Use less predictable audit procedures.
c. Only use certified public accountants on the
engagement.
d. Place increased emphasis on the audit of objective
transactions rather than subjective transactions.
14. As part of designing and performing procedures to
address management override of controls, auditors
must perform which of the following procedures?
Examine all journal Review accounting
entries above materiality estimates for biases
a. Yes Yes
b. No No
c. Yes No
d. No Yes
Evaluating the Audit Evidence and Results of Audit
Circumstances that Indicate the Possibility of Fraud
15. 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.
16. 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.
17. Which of the following might be considered a "red flag"
indicating possible fraud in a large manufacturing
company with several subsidiaries?
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a. The existence of a financial subsidiary.
b. A consistent record of above average return on
investment for all subsidiaries.
c. Complex sales transactions and transfers of funds
between affiliated companies.
d. Use of separate bank accounts for payrolls by each
subsidiary.
Communicating Misstatements Resulting from Fraud
18. 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
19. Protection Transparency, Inc. is being audited by
Messer and Bromely, LLP. During the assessment of
fraud, Messer and Bromely discover that the controller
has been creating fictional sales and posting them to
the general ledger. Who should the auditors make
aware of this issue?
a. Protection Transparency's legal counsel.
b. The law enforcement agency.
c. The chairman of audit committee.
d. The predecessor auditor.
Management Representations
20. 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
Withdrawing from engagement
21. 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
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Documentation
22. PSAs require auditors to document which of the
following matters related to the auditor’s consideration
of material misstatements due to fraud?
a. Reasons supporting a conclusion that there is not a
significant risk of material improper expense
recognition.
b. Procedures performed to obtain information
necessary to identify and assess the risks of
material fraud.
c. Results of the internal auditor’s procedures
performed to address the risk of management
override of controls.
d. Discussions with management regarding
separation of duties.
Non-compliance with Laws and Regulations
Nature, Definition and Types
23. 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 though
they are unrelated to the entity’s business
activities
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.
Responsibility for Compliance with Laws and Regulations
24. 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
25. Which of the following is incorrect about the auditor’s
responsibility for evaluating noncompliance by the
entity to laws and regulations?
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12
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.
Indications of Non-Compliance with Laws and Regulations
26. 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
27. 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. Purchasing at prices significantly above or below
market price.
c. Unauthorized transactions or improperly
recorded transactions.
d. Payments with proper exchange control
documentation.
Audit Procedures When Non-Compliance Is Identified or
Suspected
28. 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. 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.
d. Determine the reliability of management’s
representations.
29. 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 direct-
effect illegal acts is similar to the responsibility to
detect fraud.
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d. The auditor’s responsibility for detecting indirect-

effect illegal acts is similar to the responsibility to
detect fraud.
Reporting of Identified or Suspected Non-Compliance
30. 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. Contact the local law enforcement officials
regarding potential criminal wrongdoing.
d. Consider the impact of the illegal act on the
relationship with the company’s management.
- now do the DIY drill -

DO-IT-YOURSELF (DIY) DRILL

1. Which of the following are most often involved in
7. Which of the following is least likely to be required on
perpetrating fraud in financial statement
an audit in accordance with PSAs?
reporting?
a. Test appropriateness of journal entries and
a. The auditors and the attorneys.
adjustment.
b. The audit committee members.
b. Review accounting estimates for biases.
c. The chief executive and chief financial officers.
c. Evaluate the business rationale for significant
d. The accounts payable clerks.
unusual transactions.
2. Audits of financial statements are designed to obtain d. Make a legal determination of whether fraud has
reasonable assurance of detecting material occurred.
misstatements due to
8. How will the results of the auditor's assessment of
a. b. c. d.
fraud risk factors further affect the planned audit
Errors Yes Yes Yes No
Fraudulent financial Yes Yes No Yes procedures?
reporting a. Audit procedures and fraud assessment do not
Misappropriation of Yes No Yes No relate.
assets b. The assessment may require a re-audit of previous
Direct-effect illegal acts Yes No Yes No resort to management inquiry.
d. turn the audit over to forensic accountants.
3. Which of the following most accurately defines
professional skepticism as it is used in auditing
standards?
a. It either assumes management is honest or slightly
dishonest, but neither all the time.
b. It neither assumes that management is dishonest
nor assumes unquestioned honesty.
c. It assumes management is honest most of the
time.
d. It assumes that management is dishonest in only
rare instances.
4. Brainstorming about the manner in which fraud may
be committed should include all of the following
except
a. how management could perpetrate and conceal
fraudulent financial reporting
b. any unusual or unexplained changes in behavior or
lifestyle of management or employees
c. any fraud risk factors observed to be present in
the engagement
d. all of the above
5. Which of the following best represents actions
that may indicate fraud is pervasive throughout
the company under audit?
a. The company's management negotiates deals
with vendors in such a manner as to pay lower
prices.
b. The company's management drives luxury vehicles
and takes personal vacations to exotic places.
c. The company's management takes an
overly aggressive approach to revenue
recognition.
d. The company's management estimates bad debts
using an aged accounts receivables ledger rather
than as a percent of sales.
6. If the audit team discovers that fraud risk factors
are present on an engagement, it should then:
a. resign from the client and inform the audit
committee and regulatory authorities.
b. modify procedures to actively search for the
existence of fraud.
c. reduce the amount of evidence required and
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 CPART GETS GMRC CPA REVIEW CENTER
periods.
c. By the assignment of qualified audit staff to
risky areas of the engagement.
d. Management will be called upon to assist
in coordinating audit procedures.
9. 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. Fewer responses to confirmations than
anticipated or a greater number of responses
than anticipated.
b. Large numbers of debit entries and
other adjustments made to accounts
receivable records.
c. Missing inventory or physical assets of
significant magnitude.
d. Unusual discrepancies between the entity's
records and confirmation replies.
10. If an auditor believes a client may have committed
illegal acts, which of the following actions should
the auditor take?
a. Consult with the client’s counsel and the
auditor’s counsel to determine how the
suspected illegal acts will be communicated to
stockholders.
b. Extend auditing procedures to determine
whether the suspected illegal acts have a
material effect on the financial statements.
c. Make inquiries of the client’s management and
obtain an understanding of the circumstances
underlying the acts and of other evidence to
determine the effects of the acts on the
financial statements.
d. Notify each member of the audit committee of
the board of directors about the nature of the
acts and request that they advise an approach to
be taken by the auditor.
11. Which of the following is an auditor responsible for
concerning the detection of illegal activities of an
audit client?
a. Assess the inherent risk of material
misstatements due to illegal acts
b. Monitor legal requirements and ensure that the
client’s operating procedures are designed to
meet these requirements, for the period under
audit
c. Ensure that the client appoints an audit committee

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d. Ensure that the client’s internal auditors act in an
ethical manner
12. An auditor who discovers that a client's employees
paid small bribes to municipal officials most likely
would withdraw from the engagement if
a. The payments violated the client's policies
regarding the prevention of illegal acts.
b. The client receives financial assistance from a
federal government agency.
c. Documentation that is necessary to prove that the
bribes were paid does not exist.
d. Management fails to take the appropriate remedial
action and reliance on management’s
representation becomes doubtful.
13. If an illegal act is discovered during the audit of a
publicly held company, the auditor should
a. Notify the regulatory authorities.
b. Determine who was responsible for the act.
c. Modify the extent of auditing procedures.
d. Report the act to high-level personnel within the
client's organization.
14. Which of the following is least likely to be included in
an auditor's inquiry of management while obtaining
information to identify the risks of material
misstatement due to fraud?
a. Are financial reporting operations controlled by and
limited to one location?
b. Does it have knowledge of fraud or suspect fraud?
c. Does it have programs to mitigate fraud risks?
d. Has it reported to the audit committee the nature
of the company's internal control?
15. Which of the following could indicate that the risk of
fraud and other irregularities perpetrated by senior
management is higher than normal?
a. There are very few related party transactions.
b. The auditor has not audited this client before.
c. Management turnover is unusually high.
d. The auditor discovers a GAAP departure during the
audit.
16. 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. Undue time pressures imposed by management to
resolve complex or contentious issues.
b. Complaints by management about the conduct of
the audit or management intimidation of
engagement team members, particularly in
connection with the auditor’s critical assessment of
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12
audit evidence or in the resolution of potential
disagreements with management.
c. Usual delays by the entity in providing requested
information
d. An unwillingness to address identified weaknesses
in internal control on a timely basis.
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. Unwillingness by management to permit the
auditor to meet privately with those charged with
governance.
b. Accounting policies that appear to be consistent
with industry norms.
c. Frequent changes in accounting estimates that do
not appear to result from changed circumstances.
d. Tolerance of violations of the entity’s Code of
Conduct
18. Brainstorming about the manner in which fraud may
be committed should include all of the following
except
a. Consider factors that might affect management
motivation to misstate the financial statements
b. Consider weaknesses in internal control that would
allow a fraud to take place or management
override of controls
c. Consider the materiality of the individual
account balances for substantive testing
d. Consider factors that may enable an individual
capable of committing a fraud to rationalize
perpetrating it
19. In evaluating the effect of fraud upon the audit
procedures the auditor should consider
a. The type of fraud that may occur.
b. The potential significance and likelihood of
occurrence of fraud.
c. The pervasiveness of fraud detected.
d. All of the above.
20. Relative to internal controls, what is a primary risk of
fraud in the client company?
a. The risk that management overrides controls.
b. The risk that management changes controls each
year.
c. The risk that management carefully enforces
and monitors controls.
d. The risk that the audit committee
monitors controls.
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AT.0105