Questions 5, 6, and 7 were taken from the CPA exam and reprinted in the text. My normal warnings about attempting to access the solutions apply. For each question, selected the best answer and then explain why it is better than all the alternatives. Your explanations should address all the possible alternatives presented in the question. 5) The following questions address fraud risk factors and the assessment of fraud risk. a) Which of the following characteristics is most likely to heighten an auditor's concern about the risk of material misstatements due to fraud in an entity's financial statements? i) The entity's industry is experiencing declining customer demand. ii) Employees who handle cash receipts are not bonded. iii) Internal auditors have direct access to the board of directors and the entity's management. iv) The board of directors is active in overseeing the entity's financial reporting policies. Answer: Explanation: b) Which of the following circumstances is most likely to cause an auditor to increase the assessment of the risk of material misstatement of the financial statements due to fraud? i) Property and equipment are usually sold at a loss before being fully depreciated. ii) Unusual discrepancies exist between the entity's records and confirmation replies iii) Monthly bank reconciliations usually include several in-transit items. iv) Clerical errors are listed on a computer-generated exception report. Answer: Explanation: 6) The following questions concern the auditor's responses to the possibility of fraud. a) If an independent audit leading to an opinion on financial statements causes the auditor to believe that a material misstatement due to fraud exists, the auditor should first i) request that management investigate to determine whether fraud has actually occurred. ii) make the investigation necessary to determine whether fraud has actually occurred. iii) consider the implications for other aspects of the audit and discuss the matter with the appropriate levels of management. iv) consider whether fraud was the result of a failure by employees to comply with existing controls. Answer: Explanation: b) Which of the following is least likely to suggest to an auditor that the client's management may have overridden internal control? i) There are numerous delays in preparing timely internal financial reports. ii) Management does not correct internal control weaknesses that it knows about. iii) Differences are always disclosed on a computer exception report. iv) There have been two new controllers this year. Answer: Explanation: 7) The following question addresses fraud risks in specific audit areas and accounts. a) Which of the following internal controls will best detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars? i) Maintain a perpetual inventory of only the more valuable items, with frequent periodic verification of the validity of the perpetual inventory records. ii) Have an independent auditing firm examine and report on management's assertion about the design and operating effectiveness of the control activities relevant to inventory. iii) Have separate warehouse space for the more valuable items, with sequentially numbered tags. iv) Require an authorized officer's signature on all requisitions for the more valuable items. Answer: Explanation: 8) During audit planning, an auditor obtained the information listed in the following table. For each item, indicate whether or not you believe it is a fraud risk (yes or no), which element of the fraud triangle is involved, and explain why you believe it is a fraud risk. Note that we are not talking about evidence of fraud, just factors that might increase the risk of fraud. Item Fraud Risk? Fraud Condition Explanation 1. There are recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality. 2. The company's financial performance is threatened by a high degree of competitor and market saturation. 3. Significant operations are located and conducted across international borders or jurisdictions where differing business environments and cultures exist. 4. The company's board of directors includes a majority of directors who are independent of management. 5. New accounting pronouncements have resulted in explanatory paragraphs for consistency for the company and other firms in the industry. 6. The company has experienced low turnover in management and its internal audit function. 7. The company's controller works very hard, including evenings and weekends, and has not taken a vacation in two years. 8. Assets and revenues are based on significant estimates that involve subjective judgments and uncertainties that are hard to corroborate. 9. The company is marginally able to meet exchange listing and debt covenant requirements.

Questions 5, 6, and 7 were taken from the CPA exam and reprinted in the text. My normal warnings about attempting to access the solutions apply. For each question, selected the best answer and then explain why it is better than all the alternatives. Your explanations should address all the possible alternatives presented in the question. 1) The following questions address fraud risk factors and the assessment of fraud risk. a) Which of the following characteristics is most likely to heighten an auditor's concern about the risk of material misstatements due to fraud in an entity's financial statements? i) The entity's industry is experiencing declining customer demand. ii) Employees who handle cash receipts are not bonded. iii) Internal auditors have direct access to the board of directors and the entity's management. iv) The board of directors is active in overseeing the entity's financial reporting policies. Answer: Explanation: b) Which of the following circumstances is most likely to cause an auditor to increase the assessment of the risk of material misstatement of the financial statements due to fraud? i) Property and equipment are usually sold at a loss before being fully depreciated. ii) Unusual discrepancies exist between the entity's records and confirmation replies iii) Monthly bank reconciliations usually include several in-transit items. iv) Clerical errors are listed on a computer-generated exception report. Answer: Explanation: 2) The following questions concern the auditor's responses to the possibility of fraud. a) If an independent audit leading to an opinion on financial statements causes the auditor to believe that a material misstatement due to fraud exists, the auditor should first i) request that management investigate to determine whether fraud has actually occurred. 1 ii) make the investigation necessary to determine whether fraud has actually occurred. iii) consider the implications for other aspects of the audit and discuss the matter with the appropriate levels of management. iv) consider whether fraud was the result of a failure by employees to comply with existing controls. Answer: Explanation: b) Which of the following is least likely to suggest to an auditor that the client's management may have overridden internal control? i) There are numerous delays in preparing timely internal financial reports. ii) Management does not correct internal control weaknesses that it knows about. iii) Differences are always disclosed on a computer exception report. iv) There have been two new controllers this year. Answer: Explanation: 3) The following question addresses fraud risks in specific audit areas and accounts. a) Which of the following internal controls will best detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars? i) Maintain a perpetual inventory of only the more valuable items, with frequent periodic verification of the validity of the perpetual inventory records. ii) Have an independent auditing firm examine and report on management's assertion about the design and operating effectiveness of the control activities relevant to inventory. iii) Have separate warehouse space for the more valuable items, with sequentially numbered tags. iv) Require an authorized officer's signature on all requisitions for the more valuable items. Answer: Explanation: 2 4) During audit planning, an auditor obtained the information listed in the following table. For each item, indicate whether or not you believe it is a fraud risk (yes or no), which element of the fraud triangle is involved, and explain why you believe it is a fraud risk. Note that we are not talking about evidence of fraud, just factors that might increase the risk of fraud. 3 Item Frau Fraud C o n d i t i o n Explanation 1. There are recurrin g attempt s by manage ment to justify margin al or inappro priate account ing on the basis of materia lity. 4 2. The compan y's financia l perform ance is threaten ed by a high degree of competi tor and market saturati on. 5 3. Significant operati ons are located and conduct ed across internat ional borders or jurisdic tions where differin g busines s environ ments and cultures exist. 6 4. The compan y's board of director s include sa majorit y of director s who are indepen dent of manage ment. 5. New account ing pronou ncemen ts have resulted in explana tory paragra phs for consiste ncy for the compan y and other firms in the industry . 7 6. The compan y has experie nced low turnove r in manage ment and its internal audit functio n. 7. The compan y's controll er works very hard, includi ng evening s and weeken ds, and has not taken a vacatio n in two years. 8 8. Assets and revenue s are based on signific ant estimat es that involve subjecti ve judgme nts and uncertai nties that are hard to corrobo rate. 9. The compan y is margin ally able to meet exchan ge listing and debt covena nt require ments. 9