Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao

Since 1977
AT.3215
Considering the Risk of Frauds, Errors SOLIMAN/UY/RICAFRENTE
and Non-compliance with Laws and Regulations MAY 2022

References:
a. PSA 240 (Redrafted), The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
b. PSA 250 (Redrafted), Considerations of Laws and Regulations in an Audit of Financial Statements

LECTURE NOTES
Auditor's Responsibility for Fraud and Error
The risk of the auditor not detecting management fraud is
Introduction greater than employee fraud, because management may
override otherwise effective internal controls.
The auditor is responsible for obtaining reasonable
assurance that the financial Statements taken as a whole Responsibility of Management and Those Charged
are free from material misstatement, whether caused with Governance (TCWG) vs. that of the Auditor
by fraud or error. Hence, the auditor’s responsibility for the
detection of fraud and error is essentially the same. The primary responsibility for the prevention and detection
of fraud rests with both TCWG of the entity and
Fraud refers to an intentional act by one or more individuals management. Management shall establish a control
among management, those charged with governance environment and implement internal control policies and
(TCWG), employees, or third parties, involving the use of procedures to prevent and detect fraud. On the other hand,
deception to obtain an unjust or illegal advantage. While, TCWG, through its oversight function, shall ensure the
error pertains to unintentional misstatements or omissions integrity of accounting and financial reporting systems and
in financial statements, including the omission of an amount that appropriate controls are in place.
or disclosure. Differentiating fraud from error requires
professional judgment. The risk of not detecting fraud is On the other hand, the auditor’s responsibility is to obtain
higher than that of error because fraud may be concealed, reasonable assurance about whether the financial
especially if through collusion. statements taken as a whole are free from material
misstatement, whether caused by fraud or error. The
Although fraud is a broad legal concept, the auditor is auditor is not responsible for discovering fraud, and is not
concerned with fraud that causes a material misstatement and cannot be held responsible for the prevention of
in the financial statements. In addition, the auditor does fraud. Unless the auditor has reason to believe the
not make legal determinations of whether fraud has actually contrary, the auditor may accept records and documents as
occurred. genuine. An audit rarely involves the authentication of
documents.
Types of Fraud
Summary of Auditor’s Consideration of Fraud
In relation to audit of financial statements:
Step Approach
• fraudulent financial reporting – involves intentional • Discussion among the
misstatements, including omissions of amounts or Staff discussion engagement team
disclosures in financial statements, to deceive financial Step of the risk of (Brainstorming)
statements users, normally involves management. 1. material • Consider fraud triangle
examples are the following: misstatement • Exercise professional
§ manipulation or falsification of financial records skepticism
§ misrepresentation or intentional omission of Obtain • Make inquiries of
information in the financial statements information management and others
§ intentional misapplication of accounting policies Step
needed to • Consider results of
identify risks of analytical procedures
2.
• misappropriation of assets (theft) - involves the theft of material • Consider fraud risk factors
an entity’s assets and is often perpetrated by employees misstatement • Consider other
in relatively small and immaterial amounts. however, it due to fraud information
can also involve management and TCWG. examples of For risks identified, consider
this type of fraud are the following: Identify risks • Type of risk that may
§ embezzling receipts that may result exist
§ lapping of accounts receivable Step
3.
in a material • Significance of risk
§ entity funds sent to a personal bank account misstatement (magnitude)
§ inventory items sold personally by entity employees due to fraud • Likelihood of risk
§ goods or services paid for by the entity but not • Pervasiveness of risk
received
• Consider understanding of
§ use of entity assets for personal use Assess the internal control
identified risks • Evaluate whether internal
As to perpetrator: Step
after controls address the
4.
considering identified risks
1. Management fraud – refers to fraud involving one or
internal controls • Assess risks taking into
more members of management or TCWG.
account this evaluation
2. Employee fraud – refers to fraud involving only
employees of the entity.

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As risk increases 2. Incentives or pressures – Management and employees

• Overall response: More have an incentive (e.g., benefit or enrichment) or are
experienced staff, more under pressure (e.g., threat of losing their job), which
attention to accounting provides a reason to commit fraud.
policies, less predictable
procedures 3. Opportunities – Circumstances making execution of
• For specifically identified fraud possible. These circumstances exist when a
risks: Consider the need person is generally trusted, internal control is perceived
Respond to the to be easily overridden, or the individual knows about
Step to increase the nature,
results of the
5. timing and extent of audit deficiencies in internal control.
assessment
procedures
• On all audits consider the Performing risk assessment procedures (RAP) and Related
possibility of Activities
management override of
controls (adjusting • Management and Others within the Entity
journal entries,
accounting estimates, The auditor shall make inquiries of management, and
unusual transactions) others within the entity as appropriate, to determine
• Assess risks of fraud whether they have knowledge of any actual, suspected
throughout the audit or alleged fraud affecting the entity.
• Evaluate analytical
procedures performed as The auditor shall make inquiries of internal audit to
substantive procedures determine whether it has knowledge of any actual,
and at overall review suspected or alleged fraud affecting the entity, and to
Step Evaluate audit obtain its views about the risks of fraud.
stage
6. evidence
• Evaluate risks of fraud
near completion of • Those Charged with Governance (TCWG)
fieldwork
• Respond to The auditor shall obtain an understanding of how TCWG
misstatements that may exercise oversight of management’s processes for
be due to fraud identifying and responding to the risks of fraud in the
entity and the internal control that management has
• Communicate all fraud to
established to mitigate these risks. TCWG of an entity
an appropriate level of
have oversight responsibility for systems for monitoring
management
risk, financial control and compliance with the law.
• Communicate all
management fraud to The auditor shall make inquiries of TCWG to determine
Step Communicate TCWG whether they have knowledge of any actual, suspected
7. about fraud • Communicate all material or alleged fraud affecting the entity. These inquiries are
fraud to management and made in part to corroborate the responses to the
TCWG inquiries of management.
• Determine if significant
deficiencies have been • Unusual or Unexpected Relationships Identified
identified
• Document steps 1-7 The auditor shall evaluate whether unusual or
Document • If improper revenue unexpected relationships that have been identified in
Step
consideration of recognition not performing analytical procedures, including those
8.
fraud considered a risk, related to revenue accounts, may indicate risk of
describe why material misstatement due to fraud.

The important concepts of the above steps further discussed • Other Information
below.
The auditor shall consider whether other information
Auditor’s Consideration of Fraud obtained by the auditor indicates risk of material
misstatement (ROMM) due to fraud.
Discussion Among the Engagement Team
• Evaluation of Fraud Risk Factors
This discussion shall place particular emphasis on how and
where the entity’s financial statements may be susceptible Fraud risks factors refer to events or conditions that
to material misstatement due to fraud, including how fraud indicate an incentive or pressure to commit fraud or
might occur. The team shall set aside beliefs that provide an opportunity to commit fraud.
management and TCWG are honest and have integrity.
Identifying and Assessing the ROMM Due to Fraud
Fraud Triangle
The auditor shall identify and assess the ROMM due to fraud
The three conditions (the fraud triangle or characteristics) at the financial statements level, and at the assertion level
generally present when fraud occurs are: for classes of transactions, account balances and
disclosures.
1. 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.

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EXCEL PROFESSIONAL SERVICES, INC.

whole are consistent with the auditor’s understanding of

• Risks of Fraud in Revenue Recognition the entity and its environment indicate a previously
unrecognized risk of material misstatement due to
The auditor shall, based on a presumption that there fraud.
are risks of fraud in revenue recognition, evaluate which
types of revenue, revenue transactions or assertions • Consideration of Identified Misstatements
give rise to such risks. Otherwise, auditor shall
document when this presumption is not applicable. For The auditor’s actions depend on whether the fraud that
example, when revenue recognition is a single type of has been discovered or suspected is material or
simple revenue transaction, e.g., leasehold revenue immaterial:
from a single unit rental property.
• If immaterial:
The auditor shall treat assessed ROMM due to fraud as
significant risks and accordingly, obtain an § Refer to appropriate level of management (one level
understanding of the entity’s related controls, including above the person involved)
control activities. § Gain satisfaction no financial statements effect

Responding to Assessed ROMM Due to Fraud • If material or unable to evaluate whether material or
immaterial:
• Overall Responses
§ Consider implications for audit, e.g., reliability of
The auditor shall determine overall responses to management representations
address the assessed risk of material misstatement due § Investigate further, i.e., discuss with appropriate
to fraud at the financial statements level. level of management (one level above the person
involved)
• Audit Procedures Responsive to Assessed Risks of § Obtain evidence of fraud and its effects
Material Misstatement Due to Fraud at the Assertion § Suggest client consult legal counsel
Level
Communication of Misstatements due to Fraud
The auditor shall design and perform further audit
procedures whose nature, timing and extent are In the exceptional circumstances where the auditor has
responsive to the assessed risk of material doubts about the integrity or honesty of management or
misstatement due to fraud at the assertion level. TCWG, the auditor may consider it appropriate to obtain
legal advice to assist in determining the appropriate course
• Audit Procedures Responsive to Risks Related to of action.
Management Override of Controls
• Communication To Management
Management is in a unique position to perpetrate fraud
because of management’s ability to manipulate accounting The communication enables management to act on a
records and prepare fraudulent financial statements by timely basis. The communication is made even if the
overriding controls that otherwise appears to be operating matter might be considered inconsequential (for
effectively. Due to the unpredictable way in which such example, a minor defalcation by an employee at a low
override could occur, it is a risk of material misstatement level in the entity’s organization). The determination
due to fraud and thus a significant risk. whom to communicate is a matter of professional
judgment which normally is at least one level above the
Irrespective of the auditor’s assessment of the risks of person involved.
management override of controls, the auditor shall design
and perform audit procedures to: • Communication With Those Charged With Governance

1. Test the journal entries and other adjustments made in The auditor’s communication with TCWG may be made
the preparation of the financial statements. orally or in writing. Due to the nature and sensitivity of
2. Review accounting estimates for biases. fraud involving senior management, or fraud that
3. For significant transactions that are outside the normal results in a material misstatement in the financial
course of business for the entity, or appear to be statements, the auditor reports such matters on a
unusual, the auditor shall evaluate business rationale timely basis and may consider it necessary to also
(or the lack thereof) of the transactions. report such matters in writing.

Evaluating Audit Evidence and Results of Audit In some cases, the auditor may consider it appropriate
to communicate with TCWG when the auditor becomes
Based on the audit procedures performed and the audit aware of fraud involving employees other than
evidence obtained, to evaluate whether the assessments of management that does not result in a material
the risk of material misstatement at the assertion level misstatement. Similarly, TCWG may wish to be
remain appropriate. This evaluation is primarily a informed of such circumstances.
qualitative matter based on the auditor’s judgment.
• Communications to Regulatory and Enforcement
• Analytical Procedures Performed in the Overall Review Authorities
of the Financial Statements
The auditor’s professional duty to maintain the
The auditor shall evaluate whether analytical confidentiality of client information may preclude
procedures that are performed when forming an overall reporting fraud to a party outside the client entity.
conclusion as to whether the financial statements as a However, the regulatory requirements, statute, the law

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EXCEL PROFESSIONAL SERVICES, INC.

or courts of law overrides this duty. For example, under 5. Communications about fraud made to management,
a BSP requirement, the auditor of a financial institution TCWG, regulators and others; and
has a statutory duty to report the occurrence of fraud 6. Reasons for that conclusion risk of material
to the BSP. Also, under an SEC requirement, the auditor misstatement due to fraud related to revenue
has a duty to report material audit findings, such as recognition is not applicable.
those involving fraud or error.
Auditor’s Responsibility to Consider Laws and
Management Written Representations Regulations

The auditor shall obtain written representations from Introduction

management that:
The auditor needs to consider the applicable laws and
1. It acknowledges its responsibility for internal control to regulations to the entity in financial statements audit
prevent and detect fraud; because compliance and non-compliance with those laws
2. It has disclosed to the auditor: and regulations affect the financial statements in many
ways. In addition, those laws and regulations to which an
• the results of its assessment of the risk that the entity is subject constitute the legal and regulatory
financial statements may be materially misstated framework in which the entity operates.
due to fraud;
• its knowledge or suspicion of fraud involving: Nature and Definition of Non-compliance
management; employees who have significant roles
in internal control; or others where the fraud could Non-compliance refers to acts of omission or commission by
have a material effect on the financial statements; the entity (intentional or unintentional), which are contrary
and to the prevailing laws or regulations. Such acts include
• its knowledge of any allegations of fraud, or transactions entered into by, or in the name of, the entity,
suspected fraud, affecting the entity’s financial or on its behalf, by TCWG, management or
statements communicated by employees, former employees. However, non-compliance does not include
employees, analysts, regulators or others. personal misconduct (unrelated to the business activities of
the entity) by TCWG, management or employees of the
Auditor Unable to Continue the Engagement entity.

Examples of these exceptional circumstances include: Types of Laws and Regulations

• The entity does not take the appropriate action In relation to financial statements, there are two types:
regarding fraud that the auditor considers necessary,
even when the fraud is not material to the financial 1. Direct effect–Amounts and disclosures, as a result of
statements; compliance, are reported on the financial statements
such as tax and pension laws and regulations
• The auditor’s consideration of the risk of material
misstatement due to fraud and the results of audit tests
2. Indirect effect–Relates primarily to operations of the
indicate a significant risk of material and pervasive
entity but does not have a direct effect on an entity’s
fraud; or
financial statements. However non-compliance may
• The auditor has significant concern about the
result in fines, litigation or other consequences for the
competence or integrity of management or TCWG.
entity that may have a material effect on the financial
statements. Examples may include compliance with the
If, as a result of circumstances, the auditor shall:
terms of an operating license, regulatory solvency
requirements, or environmental regulations.
1. Consider whether it is appropriate to withdraw from the
engagement; and
Responsibility for Compliance with Laws and
2. If the auditor withdraws:
Regulations
• Discuss with the appropriate level of management Responsibility of Management for Compliance with Laws and
and TCWG, including the reasons thereof; and Regulations
• Determine whether there is a professional or legal
requirement to report to the person or persons or, Management, with the oversight of TCWG, is responsible for
in some cases, to regulatory authorities. ensuring that the entity’s operations are conducted in
accordance with laws and regulations.
Documentation
Responsibility of the Auditor
The auditor’s documentation shall include the:
The auditor is responsible for obtaining reasonable
1. Significant decisions reached during ‘brainstorming’ assurance that the financial statements, taken as a whole,
regarding the susceptibility of the entity’s financial are free from material misstatement, whether caused by
statements to material misstatement due to fraud; fraud or error.
2. Identified and assessed risk of material misstatement
due to fraud at the financial statements level and at the The auditor shall identify ROMM of the financial statements
assertion level. due to non-compliance with laws and regulations. However,
3. Responses to the assessed risk of material the auditor is not responsible for preventing non-compliance
misstatements: the overall responses and the nature, and cannot be expected to detect non-compliance with all
timing and extent of further audit procedures; laws and regulations. In the absence of evidence to the
4. Results of the audit procedures; contrary, the auditor is entitled to assume the entity is in

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EXCEL PROFESSIONAL SERVICES, INC.

compliance with applicable laws and regulations affecting performing substantive tests of details of classes of
the client transactions, account balances or disclosures.

In the context of laws and regulations, the potential effects Written Representations
of inherent limitations on the auditor’s ability to detect
material misstatements are greater because: The auditor shall request management and, where
appropriate, TCWG to provide written representations that
• Many laws and regulations, relating principally to the all known instances of non-compliance or suspected non-
operating aspects of an entity, do not affect the financial compliance with laws and regulations whose effects should
statements. be considered when preparing financial statements have
• Non-compliance may be concealed, management been disclosed.
override of controls or intentional misrepresentations to
the auditor. No Identified or Suspected Non-compliance
• Whether an act constitutes non-compliance is ultimately
determined by a court of law. In the absence of identified or suspected non-compliance,
the auditor is not required to perform audit procedures
Ordinarily, the further removed non-compliance is from the regarding the entity’s compliance with laws and regulations,
events and transactions reflected in the financial other than those set out above.
statements, the less likely the auditor is to become aware
of it or to recognize the non-compliance. Audit Procedures When Non-Compliance Is Identified
or Suspected
The Auditor’s Consideration of Compliance with Laws
and Regulations The auditor shall obtain:

Obtaining an Understanding of the Legal and Regulatory 1. An understanding of the nature of the act and the
Framework circumstances in which it has occurred; and
2. Further information to evaluate the possible effect on
As part of obtaining an understanding of the entity and its the financial statements
environment, the auditor shall obtain a general
understanding of:

1. The legal and regulatory framework applicable to the

entity and the industry or sector in which the entity
operates; and
2. 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 financial statements.

Indirect Effect Laws and Regulations

The auditor shall perform the following to identify non-

compliance that may have a material effect on the financial
statements:

1. Inquiry of management and, where appropriate, TCWG,

as to whether the entity is in compliance with such laws
and regulations; and
2. Inspection of 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 financial

statements 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

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Summary of Auditor’s Responsibility for Fraud, Error and Non-compliance with Laws and Regulations
Non-compliance with laws & regulations
Errors Fraud Direct effect Indirect effect
Relate primarily to entity’s
operations but does not
Amounts and
have a direct effect on an
disclosures, as a
entity’s financial
Unintentional Intentional result of
statements. Non-
Definition misstatements or misstatements or compliance, are
compliance may result in
omissions omissions reported on the
fines, litigation or other
financial
consequences that may
statements
have a material effect on
the financial statements.
Two types—fraudulent
Mistake in processing financial reporting
accounting data, incorrect (falsification of Terms of an operating
Tax and pension
accounting estimates due accounting records) license, regulatory
Examples laws and
to oversight, mistakes in and misappropriation solvency requirements, or
regulations
application of accounting of assets environmental regulations.
principles (embezzlement or
theft)
1. Be aware of possibility
that they may have
occurred.
1. Assessment of ROMM.
2. Inquire of
2. Based on assessment,
management and
design audit to
TCWG regarding
provide reasonable
compliance.
assurance of detection
3. Inspect
of material
correspondence with
misstatements.
Detection regulatory authorities
3. Exercise due care in (Same as for
responsi- (Same as for errors) 4. 4. If specific
planning, performing, errors)
bility information comes to
and evaluating results
attention on an illegal
of audit procedures,
act with a possible
and proper degree of
material indirect
professional
financial statement
skepticism to achieve
effect, apply audit
reasonable assurance
procedures necessary
of detection.
to determine whether
illegal act has
occurred.
Reporting Modify auditor’s reports
(Same as for
responsi- for material misstatement (Same as for errors) (Same as for errors)
errors)
bility or inability to obtain SAAE

- done -

DISCUSSION QUESTIONS
Fraud and Error d. Misrepresentation in the financial statements of
events, transaction or other significant information.
Fraud vs. Error
3. The risk of not detecting a material misstatement
1. What differentiates fraud from an error? resulting from fraud is higher than the risk of not
a. Materiality. detecting a material misstatement resulting from error
b. Effect on misstatements. because
c. Intent. a. The effect of fraudulent act is likely omitted in the
d. Frequency of occurrence . accounting records.
b. Fraud is ordinarily accompanied by acts specifically
2. The following are examples of error, except designed to conceal its existence, and auditors do
a. A mistake in gathering or processing data from not make legal determinations of whether fraud has
which financial statements are prepared. actually occurred.
b. An incorrect accounting estimate arising from c. Fraud is always a result of connivance between or
oversight or misinterpretation of facts. among employees.
c. A mistake in the application of accounting principles d. The auditor is responsible to detect errors but not
relating to measurement, recognition, classification, fraud.
presentation, or disclosure.

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EXCEL PROFESSIONAL SERVICES, INC.

Types of Fraud and fraud will be detected in the ordinary course of

the examination.
4. The two types of intentional misstatements that are
relevant to the auditor’s consideration of fraud include, 9. When comparing the auditor’s responsibility for
misstatements resulting from fraudulent financial detecting employee fraud and for detecting errors, the
reporting and misstatements resulting from profession has placed the responsibility:
misappropriation of assets. Fraudulent financial a. more on discovering errors than employee fraud.
reporting least likely involve b. more on discovering employee fraud than errors.
a. Deception such as manipulation, falsification c. equally on discovering either one.
(including forgery), or alteration of accounting d. on the senior auditor for detecting errors and on the
records or supporting documents from which the manager for detecting employee fraud.
financial statements are prepared
b. Misrepresentation in, or intentional omission from, 10. Which of the following represents the primary difference
the financial statements of events, transaction or between an audit and forensic accounting?
other significant information a. An audit has the focused responsibility to detect
c. Intentional misapplication of accounting principles fraud in the client organization while forensic
relating to measurement, recognition, classification, accounting sets out to prevent fraud.
presentation, or disclosure b. An audit has no responsibility for fraud while
d. Embezzling receipts, stealing physical assets or forensic accounting provides an audit specific to
intellectual property, causing an entity to pay for material fraud discovery.
goods and services not received, or using an entity’s c. An audit must follow Generally Accepted Auditing
assets for personal use. Standards while the forensic accountant is bound to
Generally Accepted Fraud Standards.
5. Who is most likely to perpetrate fraudulent financial d. An audit utilizes sampling techniques to detect
reporting? material misstatements while forensic accounting
a. Members of the board of directors examines the entire population of fraudulent
b. Production employees transactions.
c. Management of the company
d. The internal auditors Auditor's Fraud Consideration

6. Misappropriation of assets is normally perpetrated by: Risk Assessment Procedures

a. members of the board of directors.
b. employees at lower levels of the organization. 11. Sources of information gathered to assess fraud risks
c. management of the company. usually do not include:
d. the internal auditors. a. Analytical procedures.
b. Inquiries of management and others within the
7. In comparing management fraud with employee fraud, entity.
the auditor’s risk of failing to discover the fraud is c. Communication among audit team members.
a. Greater for employee fraud because of the higher d. Review of corporate charter and bylaws.
crime rate among blue collar workers
b. Greater for management fraud because of 12. When planning the audit, the auditor should make
management’s ability to override existing internal inquiries of management in order to do the following,
controls that is always presumed to exist in an audit except
of financial statements. a. Obtain an understanding of management’s
c. Greater for employee fraud because of the larger assessment of the risk that the financial statements
number of employees in the organization may be materially misstated as a result of fraud.
d. Greater for management fraud because managers b. Obtain an understanding of the accounting and
are inherently smarter than employees internal control systems management has put in
place to address fraud and error.
Responsibilities for Fraud c. Determine whether management and other within
the entity (e.g., internal audit function) have
8. Which statement(s) is(are) incorrect regarding the knowledge of any actual, suspected or alleged fraud
auditor’s responsibility to consider fraud and error in an affecting the entity.
audit of financial statements? d. Provide useful information concerning the risks of
a. The auditor is not and cannot be held responsible material misstatements in the financial statements
for the prevention of fraud and error being the resulting from management fraud.
primary responsibility of both the management and
those charged with governance. Engagement Team Discussion (‘Brainstorming’)
b. When planning and performing audit procedures
and evaluating and reporting the results thereof, 13. According to professional audit standards, how might an
the auditor should consider the risk of understanding of the nature of fraud that may occur in
misstatements in the financial statements resulting the client organization best be identified by the audit
from fraud. firm?
c. In planning the audit, the auditor should discuss a. Fraud training courses from actual corporate fraud
with other members of the audit team the ex-criminals.
susceptibility of the entity to material statements in b. Conducting a brainstorming meeting with the
the financial statements resulting from fraud or members of the audit team.
error and exercise professional skepticism, which is c. Circulating a survey to the client company
the best method of the auditor to detect fraud. employees for completion.
d. The auditor should design audit programs that will d. Discussions with other CPA firms.
provide reasonable assurance that material errors

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14. Which of the following issues is normally part of the a. Capitalization of repairs and maintenance into the
“brainstorming” session required by PSAs? property, plant, and equipment asset account.
a. b. c. d. b. Improper revenue recognition.
How assets could be c. Improper interest expense accrual.
misappropriated Yes Yes Yes No d. Introduction of significant new products.
How and where the entity’s
financial statements are Responding to Assessed ROMM due to fraud
susceptible to material
misstatements due to Yes Yes Yes Yes 20. Statement 1: Auditors are required to perform
fraud extended audit procedures to detect material errors and
The need for professional irregularities if previously performed examinations
skepticism Yes No No Yes indicate that they may exist.
The audit team’s response to
potential fraud risks Yes Yes No No Statement 2: Audit procedures that are effective for
detecting an unintentional misstatement may be
Identifying and Assessing the ROMM due to Fraud ineffective for an intentional misstatement that is
concealed through collusion.
15. The fraud triangle consists of three components a. True, true c. False, true
(incentive or pressure, opportunity, and attitude or b. True, false d. False, false
rationalization). Which of the three components are
present in most every fraud? 21. Which of the following is most likely to be an overall
a. All three factors are usually present when fraud response to fraud risks identified in an audit?
occurs. a. Supervise members of the audit team less closely
b. Pressure and opportunity and rely more upon judgment.
c. Opportunity and rationalization b. Only use certified public accountants on the
d. Rationalization and pressure engagement.
c. Place increased emphasis on the audit of objective
16. Categories of fraud risk factors (whose presence often transactions rather than subjective transactions.
has been observed in circumstances where frauds have d. Use less predictable audit procedures.
occurred) in relation to misstatements arising from
misappropriation of assets and fraudulent financial 22. Which of the following is most likely to be a response to
reporting are opportunities, attitudes or the auditor's assessment that the risk of material
rationalizations, and pressures or incentives. Which of misstatement due to fraud for the existence of inventory
the following creates an opportunity for fraud to be is high?
committed in an organization? a. Observe test counts of inventory at certain locations
a. Management demands financial success or is on an unannounced basis.
aggressive in its application of accounting rules. b. Perform analytical procedures rather than taking
b. Poor internal control. test counts.
c. Commitments tied to debt covenants. c. Request that inventories be counted prior to year-
d. Finding loopholes in the accounting rules to achieve end.
earnings targets. d. Request that inventory counts at the various
locations be counted on different dates so as to
17. The following are examples of circumstances that may allow the same auditor to be present at every count.
indicate the possibility that the financial statements
may contain a material misstatement resulting from 23. As part of designing and performing procedures to
fraud, except address management override of controls, auditors
a. Transactions that are recorded in a complete or must perform which of the following procedures?
timely manner or are properly recorded as to a. b. c. d.
amount, accounting period, classification, or entity Review accounting estimates
policy. for biases Yes Yes Yes No
b. Unsupported or unauthorized balances or Examine all journal entries
transactions. above materiality Yes No Yes Yes
c. Last-minute adjustments that significantly affect Examine adjusting entries Yes Yes No Yes
financial results or unusual journal entries. Review unusual transactions Yes Yes No No
d. Tips or complaints to the auditor about alleged
fraud. Conclusion and Reporting

18. The following are examples of circumstances that may 24. Communication of a misstatement resulting from fraud,
indicate the possibility that the financial statements or a suspected fraud, or error to the appropriate level
may contain a material misstatement resulting from of management on a timely basis is important because
fraud, except it enables management to take action as necessary.
a. Missing documents. Ordinarily, the appropriate level of management is
b. Documents that appear to have been altered. a. At least equal to level of persons who appear to be
c. Unavailability of other than photocopied or involved with misstatements or suspected fraud
electronically transmitted documents when b. At least one level above persons who appear to be
documents in original form are expected to exist. involved with the misstatement or suspected fraud
d. Significant explained items on reconciliations. c. The audit committee of the board of directors
d. The head of internal audit department
19. Which of the following is most likely to be presumed to
represent fraud risk on an audit? 25. The auditor least likely obtains written representations
from management that:

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EXCEL PROFESSIONAL SERVICES, INC.

a. It acknowledges its responsibility for the c. Violations of antitrust laws.

implementation and operations of accounting and d. Price fixing.
internal control systems that are designed to
prevent and detect fraud and error. 30. Which of the following statements is usually true?
b. It has disclosed to the auditor its knowledge of fraud a. It is easier for the auditor to uncover fraud than
or suspected fraud affecting the entity involving errors.
employees who have significant roles in internal b. It is easier for the auditor to uncover indirect-effect
control only. illegal acts than fraud.
c. It has disclosed to the auditor its knowledge of any c. The auditor’s responsibility for detecting indirect-
allegations of fraud, or suspected fraud affecting the effect illegal acts is similar to the responsibility to
entity’s financial statements communicated by detect fraud.
employees, former employees, analysts, d. The auditor’s responsibility for detecting direct-
regulations or others. effect illegal acts is similar to the responsibility to
d. It has disclosed to the auditor the results of its detect fraud.
assessment of the risk that the financial statements
may be materially misstated as a result of fraud. Responsibility for Compliance with Laws and Regulations
31. Which of the following is incorrect about the auditor’s
Withdrawing from Engagement Because of Fraud responsibility for evaluating noncompliance by the
entity to laws and regulations?
26. The auditor may encounter exceptional circumstances a. It is the responsibility of management, with the
that bring into question the auditors ability to continue oversight of those charged with governance, to
performing the audit, including where ensure that the entity’s operations are conducted in
a. The entity does not take the remedial action accordance with laws and regulations, including
regarding fraud that the auditor considers compliance with laws and regulations that
necessary in the circumstances, even when the determine the form or content of the entity’s
fraud is not material to the financial statements financial statements. This includes responsibility for
b. The auditor’s consideration of the risk of material the prevention and detection of non-compliance
misstatement resulting from fraud and the results with laws and regulations.
of audit tests indicate a significant risk of material b. An audit cannot be expected to detect
and pervasive fraud noncompliance with all laws and regulations.
c. The auditor has significant concern about the Detection of noncompliance, regardless of
competence or integrity of management or those materiality, requires considerations of the
charged with governance that affect the auditor's implications for the integrity of management or
ability to rely on management's representations. employees
d. All of the above c. Generally, the further removed non-compliance is
from the events and transactions reflected in the
Noncompliance with Laws and Regulations financial statements, the more likely the auditor is
to become aware of it or to recognize the possible
Definition non-compliance. This is because an illegal act by the
client often relate to operating aspects rather than
27. Which statement is incorrect regarding the auditor’s accounting aspects.
consideration of laws and regulations in an audit of d. In order to plan the audit, the auditor should obtain
financial statements? a general understanding of the legal and regulatory
a. Noncompliance refers to acts of omission or framework applicable to the entity and the industry
commission by the entity being audited which are and how the entity is complying with that
contrary to prevailing laws and regulations framework.
b. Noncompliance includes transactions entered into
by, or in the name of, the entity, or on its behalf, The Auditor’s Consideration of Compliance with Laws and
by TCWG, management or employees. Regulations
c. Noncompliance includes personal misconduct of the
entity’s management or employees unrelated to the 32. Which of the following is incorrect regarding the
business activities of the entity. auditor’s consideration of laws and regulations
d. In the absence of evidence to the contrary, the applicable to the entity?
auditor is entitled to assume the entity is in a. The auditor shall obtain a general understanding of
compliance with applicable laws and regulations applicable laws and regulations to the entity.
affecting the client. b. The auditor shall identify and assess risk of material
misstatement of financial statements relating to
Effect of Laws and Regulations on Financial Statements non-compliance with laws and regulations.
c. The auditor shall obtain sufficient appropriate audit
28. Which of the following would most likely be deemed a evidence regarding compliance of all types of laws
direct-effect illegal act? and regulations applicable to the entity.
a. Violation of employment laws. d. The auditor shall respond appropriately in instances
b. Violation of environmental regulations. of identified or suspected non-compliance with all
c. Violation of income tax laws. types laws and regulations.
d. Violation of civil rights laws.
33. In considering indirect effect laws and regulations in an
29. Which of the following illegal acts should an audit be audit of financial statements, an auditor shall
designed to obtain reasonable assurance of detecting? a. Inquire of management and those charged with
a. Securities purchased by relatives of management governance.
based on knowledge of inside information. b. Inspect correspondences with regulatory
b. Accrual and billing of an improper amount of authorities.
revenue under government contracts. c. Both a and b.

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EXCEL PROFESSIONAL SERVICES, INC.

d. Neither a nor b.
38. In assessing whether management has overlooked
34. According to PSA 250 (Consideration of Laws and relevant laws and regulations, the auditor would
Regulations in an Audit of Financial Statements), the perform all of the following except
following are indications that noncompliance may have a. Obtain written representations from management.
occurred, except b. Review relevant portions of grant and loan
a. Investigation by government departments or agreements.
payment of fines or penalties c. Confirm grant arrangements with granting
b. Adverse media comment agencies.
c. Authorized transactions or properly recorded d. Discuss laws and regulations with the entity's chief
transactions financial officer and legal counsel.
d. Purchasing at prices significantly above or below
market price 39. When an auditor becomes aware of a possible illegal act
by a client, the auditor should obtain an understanding
35. Examples of the type of information that may come to of the nature of the act to
the auditor's attention that may indicate that a. Increase the assessed level of control risk.
noncompliance with laws or regulations has occurred b. Recommend remedial actions to the audit
least likely include committee.
a. Payments for unspecified services or loans to c. Determine the reliability of management’s
consultants, related parties, employees or representations.
government employees. d. Evaluate the effect on the financial statements and
b. Payments for goods or services made other than to may consider seeking legal advice especially when
the country from which the goods or services involving members of senior management,
originated. including members of the board of directors.
c. Unauthorized transactions or improperly recorded
transactions. 40. Which of the following is the auditor least likely to do
d. Payments with proper exchange control when aware of an illegal act?
documentation. a. Discuss the matter with the client’s legal counsel.
b. Obtain evidence about the potential effect of the
36. When an auditor identifies or suspects instances of non- illegal act on the financial statements.
compliance with laws and regulations in relation to audit c. Consider the impact of the illegal act on the
of financial statements, the auditor shall relationship with the company’s management.
a. b. c. d. d. Contact the local law enforcement officials
Obtain understanding of the regarding potential criminal wrongdoing.
nature of the act. Yes Yes Yes No
Evaluate possible effect of End of AT.3215
noncompliance on financial
statements. Yes No Yes Yes
Discuss the matter with
management and TCWG. Yes Yes No Yes
Consider obtaining legal Yes Yes No No
advice.
Evaluate other audit
implications. Yes Yes No No

37. Which of the following is incorrect about the auditor’s

responsibility for evaluating noncompliance by the
entity to laws and regulations?
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.

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