(a) The requirement is to determine an auditor’s reporting responsibility when he or she has discovered that management is involved in a financially immaterial fraud. Answer (a) is correct because AU-C 240 requires that all management fraud, regardless of materiality, be reported to the audit committee. Answer (b) is incorrect because fraud is not directly reported to the Public Company Accounting Oversight Board. Answer (c) is incorrect because if anything, in addition to the audit committee, the fraud is reported to a level of management at least one level above those involved in a fraud. Answer (d) is incorrect because there is a reporting responsibility for financially immaterial management fraud.
(c) The requirement is to identify the most likely risk factor relating to fraudulent financial reporting. Answer (c) is correct because negative cash flows from operations may result in pressure upon management to overstate the results of operations. Answer (a) is incorrect because one would expect a company’s top executives to dominate management—domination by one or a few might be considered a risk factor. Answers (b) and (d) are incorrect because large amounts of cash being processed and small high-dollar inventory items are more directly related to the misappropriation of assets than they are to fraudulent financial reporting.
(b) The requirement is to identify the most likely fraud risk factor on an audit. Answer (b) is correct because the possibility of improper revenue recognition is ordinarily presumed on audits. Answers (a), (c), and (d) all represent potential risks, but risks that are not ordinarily presumed on an audit. See AU-C 240 for information on the auditor’s responsibility for the consideration of fraud in a financial statement audit.
(d) The requirement is to identify the circumstances relating to the discovery of the payment of small bribes to municipal officials that is most likely to cause an auditor to withdraw from an engagement. Answer (d) is correct because AU-C 250 (AU 317) states that management failure to take the appropriate remedial action is particularly problematical since it may affect the auditor’s ability to rely on management representation and may therefore lead to withdrawal. Answers (a), (b), and (c) all represent circumstances which the auditor will consider, but are not ordinarily considered as serious as failure to take the appropriate remedial action.
(d) The requirement is to identify the factor most likely to cause a CPA not to accept a new audit engagement. Answer (d) is correct because a part of the understanding an auditor must obtain with a client is that management is responsible for making all financial records and related information available. Accordingly, if the client refuses to make such information available the auditor is unlikely to accept the audit client. Answer (a) is incorrect because a circumstance-imposed scope limitations such as completion of the physical inventory count results in a situation in which the auditor may consider using alternative procedures (including making some test counts) to determine whether inventory counts are proper. Answer (b) is incorrect because an auditor may obtain an understanding of the client’s operations and industry while performing the audit. Answer (c) is incorrect because while a review of the predecessor auditor’s working papers is ordinarily desirable, it is not required.
(d) The requirement is to identify the factor most likely to heighten an auditor’s concern about the risk of fraudulent financial reporting. Answer (d) is correct because AU-C 240, which presents a variety of risk factors, suggests that an overly complex organizational structure is such a risk factor. Answer (a) is incorrect because large amounts of liquid assets that are easily convertible into cash represent more of a risk relating to misappropriation of assets rather than to fraudulent financial reporting. Answer (b) is incorrect because high growth, rather than low growth, is considered a risk factor. Answer (c) is incorrect because one would expect financial management’s participation in the initial selection of accounting principles.
(c) The requirement is to identify the situation in which an auditor would be most likely to withdraw from an engagement when he or she has discovered that a client’s employees have paid small bribes to public officials. Answer (c) is correct because AU-C 250 states that resignation should be considered when an illegal act does not receive proper remedial action, because such inaction may affect the auditor’s ability to rely on management representations and the effects of continued association with the client. Answer (a) is incorrect because the receipt of federal funds in such a situation is not as likely to result in auditor withdrawal as is answer (c). Answer (b) is incorrect because it seems inconsistent with the premise of the question in that, if no evidence exists, the auditor is unlikely to know that bribes have been paid. Answer (d) is incorrect because such small bribes will not ordinarily need to be disclosed. Alternatively, if the auditor believes that there is such a need, the lack of such disclosure represents a departure from generally accepted accounting principles and either a qualified or adverse opinion is appropriate.
(b) The requirement is to identify the illegal act that an audit should be designed to obtain reasonable assurance of detecting. Answer (b) is correct because the accrual and billing of an improper amount of revenue under government contracts is an illegal act with a direct effect on the determination of financial statement amounts, and audits are designed to detect such illegal acts. Answers (a), (c), and (d) are all incorrect because they represent illegal acts with an indirect financial statement effect and an audit provides no assurance that such acts will be detected or that any contingent liabilities that may result will be disclosed. See AU-C 250 for detailed guidance on auditor responsibility with respect to direct and indirect illegal acts.
(a) The requirement is to identify the small misstatement that is most likely to have a material effect on an entity’s financial statements. Answer (a) is correct because an illegal payment of an otherwise immaterial amount may be material if there is a reasonable possibility that it may lead to a material contingent liability or a material loss of revenue.
(c) The requirement is to determine what an auditor might reconsider when a client’s board of directors has refused to take any action relating to an auditor’s disclosure that the company has made immaterial illegal contributions. Answer (c) is correct because in such a circumstance the failure to take remedial action may cause an auditor to decrease reliance on management representations. Answer (a) is incorrect because the reply by the attorney is likely to disclose any claims, litigation or assessments that the client has improperly omitted from the letter of audit inquiry. Answer (b) is incorrect because the prior years’ audit programs are not being relied upon for this year’s audit. Answer (d) is incorrect because the preliminary judgment about materiality levels would not be expected to change.
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