A424 Exam 1

Chapters 1-4

Assertions

Representations, explicit or otherwise, with respect to the recognition, measurement, and disclosure of information in financial statements, which are inherent in management, representing that the financial statements are prepared in accordance with the applicable financial reporting framework. Used by the auditor to consider the different types of potential misstatements that may occur when identifying, assessing, and responding to the risks of material misstatement

Assurance services

Independent professional services that improve the quality of information, or its context, for decision makers. Encompasses attest services and financial statement audits

Attest services

Services provided by a practitioner engaged to issue a report on subject matter, or an assertion about subject matter, that is the responsibility of another party. Encompasses financial statement audits.

Audit data analytics

Using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit

Audit evidence

All the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Information to which audit procedures have been applied and consists of information that corroborates or contradicts assertions in the financial statements.Au

Audit risk

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated

Auditing

A systematic process of (1) objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and (2) communicating the results to interested users

Information asymmetry

The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does

Information risk

The risk that information circulated by a company’s management could be false or misleading

Materiality

The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users

Misstatement

A departure from the applicable reporting framework (e.g., GAAP) that, if material, causes the financial statements to not be presented fairly. May be classified as fraud (intentional), other illegal acts such as noncompliance with laws and regulations (intentional or unintentional), and errors (unintentional)

Reasonable assurance

The concept that an audit done in accordance with auditing standards may fail to detect a material misstatement in a client’s financial statements. In an auditing context this term has been defined to mean a high but not absolute level of assurance.

Reporting

The end product of the auditor’s work, indicating the auditing standards followed and expressing an opinion as to whether an entity’s financial statements are fairly presented in accordance with agreed-upon critera (e.g., GAAP)

Risk of material misstatement (RMM)

The risk that the financial statements are materially misstated prior to the audit

Unqualified/unmodified audit report

A “clean” audit report, indicating the auditor’s opinion that a client’s financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP)

An independent audit adds value to the communication of financial information because the audit

a. Confirms the exact accuracy of management’s financial representations.

b. Lends credibility to the financial statements.

c. Guarantees that financial data are fairly presented.

d. Assures the readers of financial statements that any fraudulent activity has been corrected.

b. Lends credibility to the financial statements.

Which of the following describes the reason why an independent auditor is often retained to report on financial statements?

a. Management fraud may exist, and it is more likely to be detected by independent auditors than by internal auditors.

b. Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements.

c. A misstatement of account balances may exist, and all misstatements are generally corrected as a result of the independent auditor’s work.

d. An entity may have a poorly designed internal control system.

b. Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements.

Which of the following best describes relationships among auditing, attest, and assurance services?

a. Attest is a type of auditing service.

b. Auditing and attest services represent two distinctly different types of services — there is no overlap.

c. Auditing is a type of assurance service.

d. Assurance is a type of attest service.

c. Auditing is a type of assurance service.

Which of the following statements relating to attest and assurance services is not correct?

a. Independence is an important attribute of assurance service providers.

b. Assurance services can be performed to improve the quality or context of information for decision makers.

c. Financial statement auditing is a form of attest service but it is not an assurance service.

d. In performing an attest service, the CPA determines the correspondence of the subject matter (or an assertion about the subject matter) against criteria that are suitable and available to users.

c. Financial statement auditing is a form of attest service but is not an assurance service.

For what primary purpose does the auditor obtain an understanding of the entity and its environment?

a. To determine the audit fee.

b. To decide which facts about the entity to include in the audit report.

c. To plan the audit and determine the nature, timing, and extent of audit procedures to be performed.

d. To limit audit risk to an appropriately high level.

c. To plan the audit and determine the nature, timing, and extent of audit procedures to be performed.

Which of the following statements best describes how materiality is related to audit evidence in a financial statement audit?

a. Materiality refers to the “material” from which audit evidence is developed.

b. The higher the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.

c. The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.

d. The level of materiality has no bearing on the amount of evidence the auditor must gather.

c. The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.

Which of the following is the most important reason for an auditor to gain an understanding of an audit client’s system of internal control over financial reporting?

a. Understanding a client’s system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.

b. Understanding a client’s system of internal control can help the auditor make valuable recommendations to management at the end of the engagement.

c. Understanding a client’s system of internal control can help the auditor sell consulting services to the client.

d. Understanding a client’s system of internal control is not a required part of the audit process.

a. Understanding a client’s system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.

Preliminary engagement activities include

a. Understanding the client and the client’s industry.

b. Determining audit engagement team requirements.

c. Ensuring the independence of the audit team and audit firm.

d. All of the above.

d. All of the above.

Which of the following best describes what is meant by an unqualified audit opinion?

a. An unqualified auditor’s opinion indicates that in the auditor’s opinion the client’s financial statements are not fairly enough presented in accordance with agreed-upon criteria to qualify for a clean opinion.

b. An unqualified auditor’s opinion indicates that the auditor is not qualified to express an opinion that the client’s financial statements are fairly presented in accordance with agreed-upon criteria.

c. An unqualified auditor’s opinion indicates that the auditor is expressing different opinions on each of the basic financial statements regarding whether the client’s financial statements are fairly presented in accordance with agreed-upon criteria.

d. An unqualified auditor’s opinion indicates that in the auditor’s opinion the client’s financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases.

d. An unqualified auditor’s opinion indicates that in the auditor’s opinion the client’s financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases.

The auditing standards that are used to guide the conduct of the audit are

a. Implicitly referred to in the critical audit matters section of the auditor’s standard report.

b. Explicitly referred to in the critical audit matters section of the auditor’s standard report.

c. Implicitly referred to in the basis for opinion section of the auditor’s standard report.

d. Explicitly referred to in the basis for opinion section of the auditor’s standard report.

e. Implicitly referred to in the opinion section of the auditor’s standard report.

f. Explicitly referred to in the opinion section of the auditor’s standard report.

d. Explicitly referred to in the basis for opinion section of the auditor’s standard report.

A client has used an inappropriate method of accounting for its pension liability on the balance sheet. The resulting misstatement is material, but the auditor does not consider its effect to be pervasive. The auditor is unable to convince the client to alter its accounting treatment. The rest of the financial statements are presented fairly in the auditor’s opinion. Which kind of audit report should the auditor issue under these circumstances?

a. Standard unqualified opinion.

b. Qualified opinion due to departure from GAAP.

c. Adverse opinion.

d. No opinion at all.

b. Qualified opinion due to departure from GAAP.

Audit committee

A committee consisting of members of the board of directors, charged with overseeing the entity’s system of internal control over financial reporting, internal and external auditors, and the financial reporting process. Members typically must be independent of management.

Auditing Standards of the PCAOB

Statements issued by the Public Company Accounting Oversight Board

Board of directors

Persons elected by the stockholders of a corporation to oversee management and to direct the affairs of the corporation

Business processes

Processes implemented by management to achieve entity objectives. Business processes are typically organized into the following categories: financing processes, purchasing, human resource management, inventory management, and revenue.

Code of Professional Conduct

A set of principles, rules, and interpretations that establish guidance for acceptable behavior for accountants and auditors.

Corporate governance

The oversight mechanisms in place to help ensure the proper stewardship over an entity’s assets. Management and the board of directors play primary roles, and the independent auditor plays a key facilitating role.

Ethics

A system or code of conduct based on moral duties and obligations that indicates how an individual should behave.

Generally accepted accounting principles (GAAP)

Accounting principles that are generally accepted for the preparation of financial statements in the United States. Standards are currently issued primarily by the FASB, with oversight and influence by the SEC. International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board.

Independence

A state of objectivity in fact and in appearance, including the absence of any significant conflicts of interest.

Integrated audit

An audit of both financial statements and internal control over financial reporting, provided by the external auditor. Required for public companies.

International Standards on Auditing (ISA)

Statements issued by IFAC’s International Auditing and Assurance Standards Board.

Management advisory services (MAS)

Consulting services that may provide advice and assistance concerning an entity’s organization, personnel, finances, operations, systems, or other activities.

Principles Underlying an Audit Performed in Accordance with GAAS

The ASB replaced the 10 Generally Accepted Auditing Standards with these Principles, organized into four parts: Purpose of an Audit and Premise upon which an Audit is Conducted, Auditor Responsibilities, Audit Performance, and Audit Reporting

Professionalism

Conduct, aims, or qualities that characterize a profession or professional person.

Public accounting firm

An organization created to provide professional accounting-related services, including auditing. Usually formed as a proprietorship or as a form of partnership.

Statements of Auditing Standards (SAS)

Statements issued by the AICPA’s Auditing Standards Board.

Which of the following is not a part of the role of internal auditors?

a. Assisting the external auditors.

b. Providing reports on the reliability of financial statements to investors and creditors.

c. Engaging in consulting activities.

d. Conducting operational audits.

b. Providing reports on the reliability of financial statements to investors and creditors.

Operational auditing is oriented primarily toward

a. Efficiency and future improvements to accomplish the goals of management.

b. The accuracy of data reflected in management’s financial records.

c. Verification that an entity’s financial statements are fairly presented.

d. Past protection provided by existing internal control.

a. Efficiency and future improvements to accomplish the goals of management.

Which of the following would be considered a nonattest assurance service engagement?

I. Expressing an opinion about the reliability of an entity’s financial statements.

II. Reporting that a company’s sustainability metrics are complete and accurate.

a. I only.

b. II only.

C. Both I and II.

d. Neither I or II.

d. Neither I or II.

Which of the following best place events of the last decade in proper sequence?

a. Sarbanes-Oxley Act, increased consulting services to auditees, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB.

b. Increased consulting services to auditees, Sarbanes-Oxley Act, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB.

c. Enron and other scandals, Sarbanes-Oxley Act, increased consulting services to auditees, prohibition of most consulting work for auditees, establishment of PCAOB.

d. Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.

d. Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.

Which of the following statements best describes management’s and the external auditor’s respective levels of responsibility for a public company’s financial statements?

a. Management and the external auditor share equal responsibility for the fairness of the entity’s financial statements in accordance with GAAP.

b. Neither management nor the external auditor has significant responsibility for the fairness of the entity’s financial statements in accordance with GAAP.

c. Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

d. Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides a guarantee that the statements are free of material misstatement.

c. Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions?

a. To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity’s information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed.

b. To achieve its strategies, a business formulates objectives and implements processes, which are carried out through the entity’s information and internal control systems. Transactions are conducted to ensure that the processes are properly executed, captured, and processed.

c. To achieve its objectives, a business formulates strategies to implement its transactions, which are carried out through business processes. The entity’s information and internal control systems must be designed to ensure that the processes are properly executed, captured, and processed.

d. To achieve its business processes, a business formulates objectives, which are carried out through the entity’s strategies. The entity’s information and internal control systems must be designed to ensure that the entity’s strategies are properly executed, captured, and processed.

a. To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity’s information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed.

The Public Company Accounting Oversight Board

a. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.

b. Is a quasi-governmental organization that has legal authority to set accounting standards for public companies.

c. Is a quasi-governmental organization that was a policy to ignore public comment and input in the process of setting auditing standards.

d. Is a quasi-governmental organization that is independent of the SEC in setting auditing standards.

a. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.

Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States?

ASB; PCAOB

a. Nonpublic company audits; Nonpublic company audits

b. Public company audits; Public company audits

c. Nonpublic company audits; Public company audits

d. Public company audits; Nonpublic company audits

c. Nonpublic company audits; Public company audits

Which of the following best describes the general character of the section of the “Principles Underlying an Audit of Financial Statements,” titled “Performance”?

a. Description of the competence, independence, and professional care of persons performing the audit.

b. Criteria for the content of the auditor’s report on financial statements and related footnote disclosures.

c. Criteria for audit planning and evidence gathering.

d. The need to maintain an independence of mental attitude in all matters relating to the audit.

c. Criteria for audit planning and evidence gathering.

Analytical procedures

Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data

Audit commitee

A subcommittee of the board of directors that is responsible for the financial reporting and disclosure process

Audit procedures

Specific acts performed as the auditor gathers evidence to determine if specific audit objectives are being met

Audit strategy

The auditor’s plan for the expected conduct, organization, and staffing of the audit

Dual-purpose tests

Tests of transactions that both evaluate the effectiveness of controls and detect monetary errorsE

Engagement letter

A letter that formalizes the contract between the auditor and the entity and outlines the responsibilities of both parties

Illegal act

A violation of laws or government regulations

Internal audit function (IAF)

An independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes

Misstatement

A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be presented fairly in accordance with the applicable financial reporting framework

Overall materiality (Planning materiality)

The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users

Risk assessment procedures

The audit procedures designed and performed to identify and assess the risks of material misstatements, whether due to fraud or error, at the financial statement and assertion levels

Specialist

A person or firm possessing special skill or knowledge in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. May be either an auditor’s employed (internal) or an auditor’s engaged (external)

Substantive procedures

Audit procedures performed to test material misstatements in an account balance or disclosure component of the financial statements

Substantive tests of transactions

Tests to detect errors or fraud in individual transactions

Tests of controls

Audit procedures performed to test the operating effectiveness of controls preventing, or detecting and correcting, material misstatements at the relevant assertion level

Tests of details

Substantive tests that concentrate on the details of items contained in the account balance and disclosure

Tolerable misstatement (Performance materiality)

The amount of the overall materiality that is used to establish a scope for the audit procedures for the individual account balance or disclosures

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor’s

a. Awareness of the consistency in the application of generally accepted accounting principles between periods.

b. Evaluation of all matters of continuing accounting significance.

c. Opinion of any subsequent events occurring since the predecessor’s audit report was issued.

d. Understanding as to the reasons for the change of auditors.

d. Understanding as to the reasons for the change of audit

A written understanding between the auditor and the entity concerning the auditor’s responsibility for fraud is usually set forth in a(n)

a. Internal control letter.

b. Letter of audit inquiry.

c. Management letter.

d. Engagement letter.

d. Engagement letter.

If the independent auditors decide that it is efficient to consider how the work performed by the internal auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal auditors’

a. Competence and objectivity.

b. Efficiency and experience.

c. Independence and review skills.

d. Training and supervisory skills.

a. Competence and objectivity.

During the initial planning phase of an audit, a CPA most likely would

a. Identify specific internal control activities that are likely to prevent fraud.

b. Evaluate the reasonableness of the entity’s accounting estimates.

c. Discuss the timing of the audit procedures with the entity’s management.

d. Inquire of the entity’s attorney if it is probable that any unrecorded claims will be asserted.

c. Discuss the timing of the audit procedures with the entity’s management.

As generally conceived, the audit committee of a publicly held company should be made up of

a. Representatives of the major equity interests (preferred stock, common stock).

b. The audit partner, the chief financial officer, the legal counsel, and at least one outsider.

c. Representatives from the entity’s management, investors, suppliers, and customers.

d. Members of the board of directors who are not officers or employees.

d. Members of the board of directors who are not officers or employees.

When planning an audit, an auditor should

a. Consider whether the extent of substantive procedures may be reduced based on the results of the tests of controls.

b. Determine overall materiality for audit purposes.

c. Conclude whether changes in compliance with prescribed internal controls justify reliance on them.

d. Evaluate detected misstatements.

b. Determine overall materiality for audit purposes.

Which of these statements concerning illegal acts by clients is correct?

a. An auditor’s responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud.

b. An audit in accordance with auditing standards normally includes audit procedures specifically designed to detect illegal acts that have an indirect but material effect on the financial statements.

c. An auditor considers illegal acts from the perspective of the reliability of management’s representations rather than their relation to audit objectives derived from financial statement assertions.

d. An auditor has no responsibility to detect illegal acts by clients that have an indirect effect on the financial statements.

a. An auditor’s responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud.

The engagement partner and manager review the work of engagement team members to evaluate which of the following?

a. The work was performed and documented.

b. The objectives of the procedures were achieved.

c. The results of the work support the conclusions reached.

d. All of the above.

d. All of the above.

Tolerable misstatement is

a. The amount of misstatement that management is willing to tolerate in the financial statements.

b. Materiality for the balance sheet as a whole.

c. Materiality for the income statement as a whole.

d. Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures.

d. Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures.

Which of the following would an auditor most likely use in determining overall materiality when planning the audit?

a. The anticipated sample size of the planned substantive tests.

b. The entity’s income before taxes for the period-to-date (e.g., six months).

c. The results of tests of controls.

d. The contents of the engagement letter.

b. The entity’s income before taxes for the period-to-date (e.g., six months).

Business risk

A risk resulting from significant conditions, events, circumstances, and actions or inactions that could adversely affect an entity’s ability to achieve its objectives and execute its strategies or from the setting of inappropriate objectives and strategies.

Control risk

The risk that a misstatement that could occur in assertion about an account or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Detection risk

The risk that the procedures performed by the auditor will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Engagement risk

The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.

Errors

Unintentional misstatements or omissions of amounts or disclosures.

Factual misstatements

These are misstatements about which there is no doubt. For example, an auditor may test a sales invoice and determine that the prices applied to the products ordered are incorrect. Once the products are correctly priced, the amount of the misstatement is known. In such cases, the auditor knows the exact amount of the misstatement.

Fraud

An intentional act by one or more among management, those charged with governance, employees, or third parties, involving the use of deception that results in a misstatement in the financial statements.

Inherent risk

The susceptibility of an assertion in an account or disclosure to a misstatement due to error or fraud that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Judgmental misstatements

These are misstatements that arise from the judgments of management concerning accounting estimates that the auditor considers unreasonable or the selection or application of accounting policies that the auditor considers inappropriate.

Nonsampling risk

The risk that auditors will make judgment errors caused by the use of inappropriate audit procedures or misinterpretation of audit evidence and failure to recognize a misstatement or deviation.

Projected misstatements

These are the auditors best estimate of misstatements in populations, involving the projection of misstatements identified in an audit sample to the entire population from which the sample was drawn.

Risk assessment

The identification, analysis, and management of risks relevant to the preparation fo financial statements that are fairly presented in conformity with GAAP.

Scope of the audit

Refers to the nature, timing, and extent of audit procedures, where nature refers to the type of evidence; timing refers to when the evidence will be gathers; and extent refers to how much of the type of evidence will be evaluated.

Significant risk

An identified risk of material misstatement (1) for which the assessment of inherent risk is close to the upper end of the spectrum of inherent risk due to the degree to which inherent risk factors affect the combination of the likelihood of a misstatement occurring and the magnitude of the potential misstatement should that misstatement occur, or (2) that is to be treated as a significant risk in accordance with the requirements of other auditing standards.

Which of the following concepts are pervasive in the application of auditing standards?

a. Internal control.

b. Expected misstatement.

c. Control risk.

d. Materiality and audit risk.

d. Materiality and audit risk.

The existence of audit risk is recognized by the statement in the auditor’s standard report that the auditor

a. Obtains reasonable assurance about whether the financial statements are free of material misstatement.

b. Assesses the accounting principles used and evaluates the overall financial statement presentation.

c. Realizes that some matters, either individually or in the aggregate, are important, while other matters are not important.

d. Is responsible for expressing an opinion on the financial statements, which are the responsibility of management.

a. Obtains reasonable assurance about whether the financial statements are free of material misstatement.

Risk of material misstatement refers to a combination of which two components of the audit risk model?

a. Audit risk and inherent risk.

b. Audit risk and control risk.

c. Inherent risk and control risk.

d. Control risk and detection risk.

c. Inherent risk and control risk.

As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to

a. Find smaller errors.

b. Find larger errors.

c. Increase the tolerable misstatements in the accounts.

d. Decrease the risk of overreliance.

a. Find smaller errors.

Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of the financial statements?

a. Turnover of senior accounting personnel is low.

b. Insiders recently purchased additional shares of the entity’s stock.

c. Management places substantial emphasis on meeting earnings projections.

d. The rate of change in the entity’s industry is slow.

c. Management places substantial emphasis on meeting earnings projections.

Which of the following is a misappropriation of assets?

a. Classifying inventory held for resale as supplies.

b. Investing cash and earning at a 3 percent rate of return as opposed to paying off a loan with an interest rate of 7 percent.

c. An employee of a consumer electronics store steals 12 CD players.

d. Management estimates bad debt expense as 2 percent of sales when it actually expects bad debt equals 10 percent of sales.

c. An employee of a consumer electronics store steals 12 CD players.

Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required?

a. Whether management has ever intentionally violated the securities law.

b. Whether management has any knowledge of fraud that has been perpetrated on or within the entity.

c. Management’s attitude toward regulatory authorities.

d. Management’s attitude about hiring ethical employees.

b. Whether management has any knowledge of fraud that has been perpetrated on or within the entity.

Which of the following is an example of fraudulent financial reporting?

a. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales.

b. An employee diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses.

c. An employee steals inventory, and the shrinkage is recorded as a cost of goods sold.

d. An employee borrows small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense.

a. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales.