No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

AT03-08 – Fraud, Error and NOCLAR

1. Statement 1: The distinguishing factor between fraud and error is whether the
underlying actions that result in the misstatements of the financial statements are
intentional or unintentional.
Statement 2: Since the possible impact of material misstatements due to fraud is
greater than that of errors, the auditor has greater responsibility to provide
reasonable assurance that fraud is detected in the course of the audit.
a. True, True
b. True, False
c. False, True
d. False, False

2. Which of the following is a category of fraud?

Fraudulent financial reporting Misappropriation of assets
a. Yes Yes
b. No No
c. Yes No
d. No Yes

3. Which of the following is one of the conditions for fraud described in PSA 240?
Attitudes/rationalization Risk Factors Opportunities
a. Yes No Yes
b. No Yes Yes
c. Yes No No
d. No Yes No

4. Why is it more likely that an auditor would not be able to detect management fraud
compared to employee fraud?
a. Statistically, there is a higher crime rate among blue collar workers.
b. There are less management personnel compared to rank-and-file
employees.
c. Managers are inherently smarter than regular employees.
d. Management has an ability to override existing controls that is always
presumed to exist in an audit of financial statements.

5. Management is responsible for:

Identifying and measuring fraud risks Taking steps to mitigate identified risks
a. Yes Yes
b. No No
c. Yes No
d. No Yes

6. Which of the following is not a factor that relates to opportunities to commit

fraudulent financial reporting?
a. Lack of controls related to the calculation and approval of accounting
estimates.
b. Ineffective oversight of financial reporting by the board of directors.
c. Management's practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit, and information technology staff.

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JABELLAR/AIBAY/AJABINAL/RBERCASIO/JMAGLINAO/RSORIANO
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

7. Which of the following is a factor that relates to incentives or pressures to commit

fraudulent financial reporting?
a. Significant accounting estimates involving subjective judgments.
b. Excessive pressure for management to meet debt repayment requirements.
c. Management's practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit, and information technology staff.

8. Which of the following is a factor that relates to attitudes or rationalization to

commit fraudulent financial reporting?
a. Significant accounting estimates involving subjective judgments.
b. Excessive pressure for management to meet debt repayment requirements.
c. Management's practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit and information technology staff.

9. Which of the following fraudulent entries is most likely to be made to conceal the
theft of an asset?
a. Debit another asset account and credit the asset.
b. Debit expenses and credit the asset.
c. Debit the asset and credit another asset account.
d. Debit revenue and credit the asset.
Answer (A) is incorrect because This entry would not permanently conceal the fraud. It would simply shift the
irreconcilable balance to another asset account.
Answer (B) is correct. Most fraud perpetrators attempt to conceal their theft by charging it against an expense account.
The result is that the recorded asset balance equals the actual amount on hand, and applying procedures to it will not
detect the theft.
Answer (C) is incorrect because Debiting the stolen asset account simply increases the discrepancy between the
recorded amount and the amount on hand.
Answer (D) is incorrect because An entry decreasing revenue is unusual and would attract attention.

10. As part of designing and performing procedures to address management override

of controls, auditors must perform which of the following procedures?
(1)Examine all journal entries above the level of materiality
(2)Review accounting estimates for biases
a. (1)Yes (2)Yes
b. (1)No (2)No
c. (1)Yes (2)No
d. (1)No (2)Yes

11. The following statements relate to communication of misstatements resulting from

fraud to management and to those charged with governance. Which is false?
a. The auditor need not bring to the attention of those charged with
governance any material weaknesses in internal control related to the
prevention and detection of fraud.
b. If the auditor has identified a fraud, whether or not it results in a material
misstatement in the financial statements, the auditor should communicate
these matters to the appropriate level of management on a timely basis,
and consider the need to report such matters to those charged with
governance.
c. If the auditor has obtained evidence that indicates that fraud may exist (even
if the potential effect on the financial statements would not be material), the
auditor should communicate these matters to the appropriate level of
management on a timely basis, and consider the need to report such
matters to those charged with governance.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

d. The auditor's communication with those charged with governance may be

made orally or in writing.

12. Fraud involving one or more members of management or those charged with
governance is referred to as
a. Management fraud.
b. Employee fraud.
c. Fraudulent financial reporting.
d. Misappropriation of assets.

13. The auditor is concerned with fraud that causes a material misstatement in the
financial statements. There are two types of intentional misstatements that are
relevant to the auditor: misstatements resulting from fraudulent financial reporting
and misstatements resulting from
a. Management fraud.
b. Employee fraud.
c. Misappropriation of assets.
d. Collusion within the entity or with third parties.

14. Fraudulent financial reporting involves intentional misstatements including

omissions of amounts or disclosures in financial statements to deceive financial
statement users. It may be accomplished in a number of ways, including
a. Embezzling receipts.
b. Stealing physical assets or intellectual property.
c. Using an entity's assets for personal use.
d. Manipulation, falsification, or alteration of accounting records or supporting
documentation from which the financial statements are prepared.

15. When obtaining an understanding of the entity and its environment, including its
internal control, the auditor may identify events or conditions that indicate an
incentive or pressure to commit fraud or provide an opportunity to commit fraud.
Such events or conditions are referred to as
a. Fraud conditions
b. Fraud risk factors.
c. Fraudulent activities.
d. Fraud environment.

16. Audit risk has three components: inherent risk, control risk, and detection risk.
Which of the following statements is correct?
a. Detection risk is a function of the efficiency of an auditing procedure.
b. Cash is more susceptible to theft than an inventory of coal because it has a
greater inherent risk.
c. The risk that material misstatements will not be prevented or detected on a
timely basis by internal control can be reduced to zero by effective controls.
d. The existing levels of inherent risk, control risk, and detection risk can be
changed at the discretion of the auditor.

17. "Error" includes

a. Engaging in complex transactions that are structured to misrepresent the
financial position or financial performance of the entity.
b. Concealing, or not disclosing, facts that could affect the amounts recorded
in the financial statements.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

c. An incorrect accounting estimate arising from oversight or misinterpretation

of facts.
d. Intentional misapplication of accounting policies relating to amounts,
classification, manner of presentation, or disclosure.

18. Which of the following statements best describes an auditor's responsibility

regarding misstatements?
a. An auditor should obtain reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether
caused by fraud or error.
b. An auditor should obtain absolute assurance that material misstatements in
the financial statements will be detected.
c. An auditor is responsible to detect material errors but has no responsibility
to detect material fraud that is concealed through employee collusion or
management override of internal control.
d. An auditor's failure to detect a material misstatement resulting from fraud is
an indication of noncompliance with the requirements of the Philippine
Standards on Auditing (PSAs).

19. Because of the risk of material misstatement, an audit of financial statements in

accordance with PSAs should be planned and performed with an attitude of
a. Impartial conservatism.
b. Objective judgment.
c. Independent integrity.
d. Professional skepticism.

20. PSA 230 (Documentation) requires the auditor to document matters which are
important in providing evidence to support the audit opinion, and states that the
working papers include the auditor's reasoning on all significant matters which
require the auditor's judgment, together with the auditor's conclusion thereon.
Which of the following should be documented by the auditor?
a. Fraud risk factors identified as being present during the auditor's risk
assessment process.
b. Auditor's responses to identified fraud risk factors.
c. Both fraud risk factors identified as being present during the auditor's risk
assessment process and the auditor's response to any such factors.
d. The standard does not require documentation of the identified fraud risk
factors and the auditor's responses to them.

21. As used in PSA 250 (Consideration of Laws and Regulations in an Audit of

Financial Statements), this term refers to acts of omission or commission by the
entity being audited, either intentional or unintentional, which are contrary to
prevailing laws or regulations.
a. Noncompliance
b. Illegal acts
c. Erotic acts
d. Unforgivable acts

22. According to PSA 250, the term "noncompliance" as used in the standard refers to
acts of omission or commission by the entity being audited, either intentional or
unintentional, which are contrary to the prevailing laws or regulations. Such acts
do not include
a. Transactions entered into by the entity.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

b. Transactions entered into in the name of the entity.

c. Transactions entered into on the entity's behalf by its management or
employees.
d. Personal misconduct (unrelated to the entity's business activities) by the
entity's management or employees.

23. The responsibility for the prevention and detection of noncompliance rests with
a. The auditor.
b. Management.
c. The auditor's lawyer.
d. The client's lawyer.

24. If the auditor concludes that the noncompliance has a material effect on the
financial statements, and has not been properly reflected in the financial
statements, the auditor should express
a. A qualified or an adverse opinion.
b. A qualified opinion or a disclaimer of opinion.
c. An adverse opinion
d. An adverse opinion or a disclaimer of opinion

25. If the auditor is precluded by the entity from obtaining sufficient appropriate audit
evidence to evaluate whether noncompliance that may be material to the financial
statements, has, or is likely to have, occurred, the auditor should express
a. A qualified or an adverse opinion.
b. A qualified opinion or a disclaimer of opinion.
c. An adverse opinion.
d. An adverse opinion or a disclaimer of opinion.

26. The following is/are the responsibility(ies) of the auditor for instances of non-
compliance with laws and regulations other than those with direct effect on the
determination of material amounts and disclosures in the financial statements.
Which is the exception?
a. Obtain sufficient and appropriate audit evidence regarding compliance with
the provisions of those laws and regulations.
b. Inquire of management and, where appropriate, those charged with
governance, as to whether the entity is in compliance with such laws and
regulations.
c. Inspecting correspondence, if any, with the relevant licensing or regulatory
authorities.
d. None of the above.

27. As part of obtaining an understanding of the entity and its environment in

accordance with PSA 315 (Redrafted) in relation to the auditor's consideration of
non-compliance, the auditor shall obtain a general understanding of:
a. The legal and regulatory framework applicable to the entity and the industry
or sector in which the entity operates;
b. How the entity is complying with that framework.
c. Both A and B.
d. Neither A nor B.

28. Statement 1: If the auditor suspects that management or those charged with
governance are involved in non-compliance, the auditor shall communicate the

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JABELLAR/AIBAY/AJABINAL/RBERCASIO/JMAGLINAO/RSORIANO
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

matter to the next higher level of authority at the entity, if it exists, such as an audit
committee or supervisory board. Where no higher authority exists, or if the auditor
believes that the communication may not be acted upon or is unsure as to the
person to whom to report, the auditor shall consider the need to obtain legal advice.
Statement 2: If the auditor concludes that the non-compliance has a material effect
on the financial statements, and has not been adequately reflected in the financial
statements, the auditor shall, in accordance with PSA 705 (Revised and
Redrafted), express a qualified or disclaimer of opinion on the financial statements.
a. True, True
b. True, False
c. False, True
d. False, False

29. 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.

30. An auditor who finds that the client has committed an illegal act would be most
likely to withdraw from the engagement when the:
a. Illegal act has received widespread publicity.
b. Illegal act has material financial statement implications.
c. Auditor cannot reasonably estimate the effect of the illegal act on the
financial statements.
d. Illegal act affects auditor's ability to rely on management representations.

Key Learnings
ISA 240 - The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements
ISA 250 (Revised) - Consideration of Laws and Regulations in an Audit of Financial Statements
NOCLAR (Non-compliance with laws and regulations)

 Risk of material misstatement (RoMM) is the risk that the financial statements are materially
misstated due to fraud or error.
 RoMMs may exist at either the financial statement level or at the FSLI assertion level.
 The RoMM consists of two components: inherent risk and control risk.s
 "Significant" risks are risks which, in our judgement, because of their nature, the likelihood of the
risks occurring or the likely magnitude of potential misstatements that could result from them require
special audit consideration in terms of the nature, timing or extent of testing. Significant risks
normally represent a small subset of inherent risks.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

 Inherent risks other than significant risks are considered "Normal" under our risk assessment
framework. Normal risks relate to a range of situations, including routine transactions subject to
systematic processing, as well as more complex transactions where significant judgment is
required. Normal risks do not rise to the level of a significant risk because of either the magnitude
of potential misstatements that could result from the risk or the likelihood of the risk occurring.
 The auditor assesses the risk of material misstatement due to fraud at the financial statement level
and at the assertion level through understanding the entity and its environment, including the
entity's internal control as required by ISA 315 (Revised), and by performing other procedures as
required by ISA 240.17-24, such as inquiries of management, internal audit, those charged with
governance and others within the entity, as well as by performing risk assessment analytical
procedures, consideration of other information and evaluation of fraud risk factors.
 The auditor will also consider any unusual or unexpected relationships identified through risk
assessment analytical procedures as well as other risk factors present.
 The ISA requires that assessed risks that could result in a material misstatement due to fraud be
treated as significant risks.
 In accordance with ISA 240, one of the auditor's roles is to assess whether risk of material
misstatements may occur in a client's financial statements due to fraud and to design and perform
audit procedures that have a reasonable expectation of detecting such misstatements.
 ISA 240 presumes that there are two significant risks on every audit engagement:
- there is a rebuttable risk of fraud in revenue recognition; and
- there is a risk of management override of controls at the financial statement level.
 The auditor determines overall responses to the results of the fraud risk assessment at the financial
statement level having regard to the following:
- the assignment and supervision of personnel;
- the accounting policies used by the entity; and
- unpredictability in the selection of the nature, timing and extent of audit procedures.
 Management and those charged with governance have primary responsibility for the prevention
and detection of fraud. The auditor's role is to plan and perform an audit to obtain reasonable
assurance that the financial statements as a whole are free from material misstatement, whether
due to fraud or error (ISA 240.4 and ISA 240.5).
 The auditor is required to:
- document their assessment of fraud risk, including the procedures to be performed to address
these risks;
- remain alert to the possibility that a material misstatement due to fraud may exist during the
course of the audit;
- re-evaluate fraud risk during finalisation to determine if any additional procedures should be
performed.
 To address the significant risk of fraud related to management override of controls, the auditor is
required to design and perform audit procedures related to:
- appropriateness of journal entries and other adjustments, particularly for period-end closing
processes;
- review accounting estimates for biases; and
- understanding the business rationale for significant transactions that are outside the normal
course of business of the entity.
 The auditor is required to maintain an attitude of professional scepticism throughout the audit,
recognising the possibility that a material misstatement due to fraud could exist, notwithstanding
the auditor's past experience with the entity about the honesty and integrity of management and
those charged with governance.
 It is the responsibility of management, with the oversight of those charged with governance, to
ensure that the entity's operations are conducted in accordance with the provisions of laws and
regulations, including compliance with the provisions of laws and regulations that determine the
reported amounts and disclosures in an entity's financial statements.
 In conducting an audit of financial statements, the auditor takes into account the applicable legal
and regulatory framework.
 This ISA distinguishes the auditor's responsibilities in relation to compliance with two different
categories of laws and regulations as follows (Ref: Para A6, A12-A13):
- The provisions of those laws and regulations generally recognized to have a direct effect on
the determination of material amounts and disclosures in the financial statements such as tax
and pension laws and regulations (see paragraph 14) (Ref: Para. A12) ; and

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Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

- Other laws and regulations that do not have a direct effect on the determination of the amounts
and disclosures in the financial statements, but compliance with which may be fundamental to
the operating aspects of the business, to an entity's ability to continue its business, or to avoid
material penalties (e.g., compliance with the terms of an operating license, compliance with
regulatory solvency requirements, or compliance with environmental regulations); non-
compliance with such laws and regulations may therefore have a material effect on the financial
statements (see paragraph 15) (Ref: Para. A13).
 If the auditor becomes aware of information concerning an instance of non-compliance or
suspected non-compliance with laws and regulations, the auditor shall obtain: (Ref: Para. A17-A18)
- An understanding of the nature of the act and the circumstances in which it has occurred; and
- Further information to evaluate the possible effect on the financial statements. (Ref: Para. A19)
 Unless all of those charged with governance are involved in management of the entity, and
therefore are aware of matters involving identified or suspected non-compliance already
communicated by the auditor, the auditor shall communicate, unless prohibited by law or regulation,
with those charged with governance matters involving non-compliance with laws and regulations
that come to the auditor's attention during the course of the audit, other than when the matters are
clearly inconsequential.
 If the auditor concludes that the identified or suspected non-compliance has a material effect on
the financial statements, and has not been adequately reflected in the financial statements, the
auditor shall, in accordance with ISA 705 (Revised), express a qualified opinion or an adverse
opinion on the financial statements.
 If the auditor is precluded by management or those charged with governance from obtaining
sufficient appropriate audit evidence to evaluate whether non-compliance that may be material to
the financial statements has, or is likely to have, occurred, the auditor shall express a qualified
opinion or disclaim an opinion on the financial statements on the basis of a limitation on the scope
of the audit in accordance with ISA 705 (Revised).
 If the auditor is unable to determine whether non-compliance has occurred because of limitations
imposed by the circumstances rather than by management or those charged with governance, the
auditor shall evaluate the effect on the auditor's opinion in accordance with ISA 705 (Revised).

*End of Handout*

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