ACC 550 EXAM 2 QUESTIONS AND VERIFIED
ANSWERS
What is the most costly type of fraud? - Answers - Financial Reporting Fraud
What is the distinguishing factor between fraud and error? - Answers - "...whether the
underlying action that results in the misstatement of the financial statements is
intentional or unintentional"
Are auditors responsible for the detection of fraud? - Answers - "An auditor conducting
an audit in accordance with ISA's 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."
Majority of significant financial statement fraud involves - Answers - Senior
Management
Responses to address risk of management override - Answers - 1) Review accounting
estimates for biases
2) Evaluate business rationale for significant unusual transactions
3) Test appropriateness of journal entries and other adjustments...
Three classifications of journal entries - Answers - 1) Standard, recurring entries
2) Non-standard entries
3) "Top-side" entries
What types of journal should you select for testing? - Answers - 1) Unrelated, unusual or
seldom-used accounts
2) Made by individuals who typically do not make entries
3) Recorded at end of period
4) Made at unusual times
5) Round numbers or consistent ending numbers
6) Unusual combinations of debits and credits
What is materiality? - Answers - The omission or misstatement of an item in a financial
report is material if, in the light of surrounding circumstances, the magnitude of the item
is such that it is probable that the judgment of a reasonable person relying upon the
report would have been changed or influenced by the inclusion or correction of the item
When do materiality decisions begin and end? - Answers - Planning to sign off
Factors used to determine materiality - Answers - 1) Use % of a benchmark to establish
materiality for F/S taken as a whole (quantitative)
,2) Adjust for qualitative considerations, including fraud
The firm's audit methodology will guide you through the process
Documentation requirements for materiality - Answers - 1) Materiality F/S as a whole
2) Materiality for specific transactions, balances
3) Performance materiality
Qualitative factors for materiality - Answers - 1) Arises from an item capable of precise
measurement or whether it arises from an estimate and, if so, the degree of imprecision
inherent in the estimate
2) Masks a change in earnings or other trends
3) Hides a failure to meet analysts' consensus expectations
4) Changes a loss into income or vice versa
5) Concerns a segment or other portion of the registrant's business that has been
identified as playing a significant role in the registrant's operations or profitability
6) Affects the registrant's compliance with regulatory requirements
7) Affects the registrant's compliance with loan covenants or other contractual
requirements
8) Effect of increasing management's compensation
9) Concealment of an unlawful transaction
Areas of an audit that use materiality - Answers - 1) Planning
2) Audit Process - material misstatements and weaknesses
3) Evaluation - F/S taken as a whole
4) Communication - Management and those with governance
Two categories of laws and regualtions - Answers - 1) Direct effect on F/S
2) Do not have direct effect on F/S
Examples of Direct Effect on F/S - Answers - 1) Tax laws affecting accruals
2) Revenue recognition under gov't contracts
3) Pension laws affecting recognition
4) Industry specific reporting requirements
5) Statutorily-mandated requirements
6) Foreign Corrupt Practices Act
Examples Do Not Have Direct Effect on F/S - Answers - 1) Operating license
2) Environmental regulations
3) Employment regulations
4) Occupational safety regulations
5) Regulatory solvency
What is the auditor's responsibility to detect noncompliance? - Answers - The auditor
should obtain sufficient appropriate audit evidence regarding material amounts and
disclosures in the financial statements that are determined by the provisions of those
,laws and regulations generally recognized to have a direct effect on the their
determination
Dealing with noncompliance, what should the auditor do to gain an understanding? -
Answers - (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
Indications of noncompliance - Answers - 1) Investigation by governmental agency
2) Violations cited by regulators
3) Unusually large payments made in cash
4) Unexplained payments of gov't officials
5) Improperly recorded transactions
6) Purchasing prices significantly above/below market
7) Adverse media comment
8) Payments to registered tax havens
What steps should an auditor take when noncompliance is identified or suspected? -
Answers - 1) Obtain understanding of the nature of the act and circumstances in which
it has occurred
2) Obtain further information to evaluate the possible effect on the financial statements
3) Discuss matter with management (at level above those involved)
4) Communicate with those charged with governance
What documentation is needed for noncompliance? - Answers - 1) Description of
identified or suspected noncompliance
2) Results of discussion with management & those charged with governance
What does an integrated audit reports on? - Answers - 1) Report on financial statements
2) Report on assessment of internal control over financial reporting
What is covered under SOX 404a? - Answers - 1) Management establish and maintain
adequate internal controls and procedures for financial reporting
2) Management issue annual report containing assessment of effectiveness of ICFR
What is covered under SOX 404b? - Answers - Auditor to attest to and report on
assessment made by management
What is management's responsibility under SOX 404a? - Answers - 1) Accept
responsibility for the effectiveness of internal control over financial reporting
2) Evaluate the effectiveness of internal control over financial reporting using suitable
control criteria
3) Support its evaluation of ICFR with sufficient evidence, including documentation
4) Present a written assessment of the effectiveness of internal control over financial
reporting as of the end of the most recent fiscal year (Item 9A of 10K)
, What are key provisions of the SEC Interpretative Guidance for management's
responsibility? - Answers - 1) Management should evaluate whether it has implemented
controls that adequately address the risk that a material misstatement of the financial
statements would not be prevented or detected in a timely manner"
2) The guidance describes a top-down, risk-based approach, including role of entity-
level controls
3) Management's evaluation of evidence about the operation of its controls should be
based on its assessment of risk"
4) The guidance provides an approach for making risk-based judgments about the
evidence needed
What are the auditor's responsibilities for ICFR? - Answers - 1) Auditor's objective in an
audit of ICFR is to express an opinion on the effectiveness of the company's ICFR
2) Auditor must plan and perform the audit to obtain competent evidence to obtain
reasonable assurance about whether a material weakness exist
True or False: A material weakness in ICFR does not exist if the financial statements
are not materially misstated - Answers - False
What are entity level controls? - Answers - ELCs are necessary for an effective system
of ICFR and may affect the other controls management deems necessary to adequately
address the financial reporting risks for a financial reporting element
What are the types of ELCs? - Answers - 1) Indirect
2) Monitoring
3) Direct
What are indirect ELCs? - Answers - Important, but has an indirect effect, on the
likelihood that a misstatement will prevented or detected on a timely basis
What are monitoring ELCs? - Answers - ELCs that are designed to identify possible
breakdowns in lower-level controls but do not by themselves adequately address
financial-reporting risks
What are direct ELCs? - Answers - Designed to operate at level of precision that would
adequately prevent or detect material misstatement on a timely basis
What examples of ELCs? - Answers - 1) Control environment
2) Management override
3) Risk assessment process
4) Centralized processes and controls
5) Monitor results of operations
6) Monitor other controls
7) Period-end financial reporting process
8) Policies over significant business control & risk management practices
ANSWERS
What is the most costly type of fraud? - Answers - Financial Reporting Fraud
What is the distinguishing factor between fraud and error? - Answers - "...whether the
underlying action that results in the misstatement of the financial statements is
intentional or unintentional"
Are auditors responsible for the detection of fraud? - Answers - "An auditor conducting
an audit in accordance with ISA's 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."
Majority of significant financial statement fraud involves - Answers - Senior
Management
Responses to address risk of management override - Answers - 1) Review accounting
estimates for biases
2) Evaluate business rationale for significant unusual transactions
3) Test appropriateness of journal entries and other adjustments...
Three classifications of journal entries - Answers - 1) Standard, recurring entries
2) Non-standard entries
3) "Top-side" entries
What types of journal should you select for testing? - Answers - 1) Unrelated, unusual or
seldom-used accounts
2) Made by individuals who typically do not make entries
3) Recorded at end of period
4) Made at unusual times
5) Round numbers or consistent ending numbers
6) Unusual combinations of debits and credits
What is materiality? - Answers - The omission or misstatement of an item in a financial
report is material if, in the light of surrounding circumstances, the magnitude of the item
is such that it is probable that the judgment of a reasonable person relying upon the
report would have been changed or influenced by the inclusion or correction of the item
When do materiality decisions begin and end? - Answers - Planning to sign off
Factors used to determine materiality - Answers - 1) Use % of a benchmark to establish
materiality for F/S taken as a whole (quantitative)
,2) Adjust for qualitative considerations, including fraud
The firm's audit methodology will guide you through the process
Documentation requirements for materiality - Answers - 1) Materiality F/S as a whole
2) Materiality for specific transactions, balances
3) Performance materiality
Qualitative factors for materiality - Answers - 1) Arises from an item capable of precise
measurement or whether it arises from an estimate and, if so, the degree of imprecision
inherent in the estimate
2) Masks a change in earnings or other trends
3) Hides a failure to meet analysts' consensus expectations
4) Changes a loss into income or vice versa
5) Concerns a segment or other portion of the registrant's business that has been
identified as playing a significant role in the registrant's operations or profitability
6) Affects the registrant's compliance with regulatory requirements
7) Affects the registrant's compliance with loan covenants or other contractual
requirements
8) Effect of increasing management's compensation
9) Concealment of an unlawful transaction
Areas of an audit that use materiality - Answers - 1) Planning
2) Audit Process - material misstatements and weaknesses
3) Evaluation - F/S taken as a whole
4) Communication - Management and those with governance
Two categories of laws and regualtions - Answers - 1) Direct effect on F/S
2) Do not have direct effect on F/S
Examples of Direct Effect on F/S - Answers - 1) Tax laws affecting accruals
2) Revenue recognition under gov't contracts
3) Pension laws affecting recognition
4) Industry specific reporting requirements
5) Statutorily-mandated requirements
6) Foreign Corrupt Practices Act
Examples Do Not Have Direct Effect on F/S - Answers - 1) Operating license
2) Environmental regulations
3) Employment regulations
4) Occupational safety regulations
5) Regulatory solvency
What is the auditor's responsibility to detect noncompliance? - Answers - The auditor
should obtain sufficient appropriate audit evidence regarding material amounts and
disclosures in the financial statements that are determined by the provisions of those
,laws and regulations generally recognized to have a direct effect on the their
determination
Dealing with noncompliance, what should the auditor do to gain an understanding? -
Answers - (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
Indications of noncompliance - Answers - 1) Investigation by governmental agency
2) Violations cited by regulators
3) Unusually large payments made in cash
4) Unexplained payments of gov't officials
5) Improperly recorded transactions
6) Purchasing prices significantly above/below market
7) Adverse media comment
8) Payments to registered tax havens
What steps should an auditor take when noncompliance is identified or suspected? -
Answers - 1) Obtain understanding of the nature of the act and circumstances in which
it has occurred
2) Obtain further information to evaluate the possible effect on the financial statements
3) Discuss matter with management (at level above those involved)
4) Communicate with those charged with governance
What documentation is needed for noncompliance? - Answers - 1) Description of
identified or suspected noncompliance
2) Results of discussion with management & those charged with governance
What does an integrated audit reports on? - Answers - 1) Report on financial statements
2) Report on assessment of internal control over financial reporting
What is covered under SOX 404a? - Answers - 1) Management establish and maintain
adequate internal controls and procedures for financial reporting
2) Management issue annual report containing assessment of effectiveness of ICFR
What is covered under SOX 404b? - Answers - Auditor to attest to and report on
assessment made by management
What is management's responsibility under SOX 404a? - Answers - 1) Accept
responsibility for the effectiveness of internal control over financial reporting
2) Evaluate the effectiveness of internal control over financial reporting using suitable
control criteria
3) Support its evaluation of ICFR with sufficient evidence, including documentation
4) Present a written assessment of the effectiveness of internal control over financial
reporting as of the end of the most recent fiscal year (Item 9A of 10K)
, What are key provisions of the SEC Interpretative Guidance for management's
responsibility? - Answers - 1) Management should evaluate whether it has implemented
controls that adequately address the risk that a material misstatement of the financial
statements would not be prevented or detected in a timely manner"
2) The guidance describes a top-down, risk-based approach, including role of entity-
level controls
3) Management's evaluation of evidence about the operation of its controls should be
based on its assessment of risk"
4) The guidance provides an approach for making risk-based judgments about the
evidence needed
What are the auditor's responsibilities for ICFR? - Answers - 1) Auditor's objective in an
audit of ICFR is to express an opinion on the effectiveness of the company's ICFR
2) Auditor must plan and perform the audit to obtain competent evidence to obtain
reasonable assurance about whether a material weakness exist
True or False: A material weakness in ICFR does not exist if the financial statements
are not materially misstated - Answers - False
What are entity level controls? - Answers - ELCs are necessary for an effective system
of ICFR and may affect the other controls management deems necessary to adequately
address the financial reporting risks for a financial reporting element
What are the types of ELCs? - Answers - 1) Indirect
2) Monitoring
3) Direct
What are indirect ELCs? - Answers - Important, but has an indirect effect, on the
likelihood that a misstatement will prevented or detected on a timely basis
What are monitoring ELCs? - Answers - ELCs that are designed to identify possible
breakdowns in lower-level controls but do not by themselves adequately address
financial-reporting risks
What are direct ELCs? - Answers - Designed to operate at level of precision that would
adequately prevent or detect material misstatement on a timely basis
What examples of ELCs? - Answers - 1) Control environment
2) Management override
3) Risk assessment process
4) Centralized processes and controls
5) Monitor results of operations
6) Monitor other controls
7) Period-end financial reporting process
8) Policies over significant business control & risk management practices
