Au2 Question 4 Assignment 4 Essay

Chapter 11 Fraud Auditing ?Review Questions 11-1Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users. Two examples of fraudulent financial reporting are accelerating the timing of recording sales revenue to increased reported sales and earnings, and recording expenses as fixed assets to increase earnings. 11-2Misappropriation of assets is fraud that involves theft of an entity’s assets.

Two examples are an accounts payable clerk issuing payments to a fictitious company controlled by the clerk, and a sales clerk failing to record a sale and pocketing the cash receipts. 11-3Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users, while misappropriation of assets is fraud that involves theft of an entity’s assets. Frauds involving financial reporting are usually larger than frauds involving misappropriation of assets, usually involve top management, and do not directly involve theft of company assets. 1-4The three conditions of fraud referred to as the “fraud triangle” are (1) Incentives/Pressures; (2) Opportunities; and (3) Attitudes/Rationalization. Incentives/Pressures are incentives of management or other employees to commit fraud. Opportunities are circumstances that allow management or employees to commit fraud. Attitudes/Rationalization are indications that an attitude, character, or set of ethical values exist that allow management or employees to commit a dishonest act or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act. 1-5The following are example of risk factors for fraudulent financial reporting for each of the three fraud conditions: ?Incentives/Pressures – The company is under pressure to meet debt covenants or obtain additional financing. ?Opportunities – Ineffective oversight of financial reporting by the board of directors allows management to exercise discretion over reporting. ?Attitudes/Rationalization – Management is overly aggressive. For example, the company may issue aggressive earnings forecasts, or make extensive acquisitions using company stock.

1-6The following are example of risk factors for misappropriation of assets for each of the three fraud conditions: ?Incentives/Pressures – The individual is unable to meet personal financial obligations. ?Opportunities – There is insufficient segregation of duties that allows the individual to handle cash receipts and related accounting records. ?Attitudes/Rationalization – Management has disregarded the inadequate separation of duties that allows the potential theft of cash receipts. 11-7Auditors use several sources to gather information about fraud risks, including: Information obtained from communications among audit team members about their knowledge of the company and its industry, including how and where the company might be susceptible to material misstatements due to fraud. ?Responses to auditor inquiries of management about their views of the risks of fraud and about existing programs and controls to address specific identified fraud risks. ?Specific risk factors for fraudulent financial reporting and misappropriations of assets. ?Analytical procedures results obtained during planning that indicate possible implausible or unexpected analytical relationships. Knowledge obtained through other procedures such as client acceptance and retention decisions, interim review of financial statements, and consideration of inherent or control risks. 11-8SAS 99 requires the audit team to conduct discussions to share insights from more experienced audit team members and to “brainstorm” ideas that address the following: 1. How and where they believe the entity’s financial statements might be susceptible to material misstatement due to fraud. This should include consideration of known external and internal factors affecting the entity that might ? reate an incentive or pressure for management to commit fraud. ?provide the opportunity for fraud to be perpetrated. ?indicate a culture or environment that enables management to rationalize fraudulent acts. 2. How management could perpetrate and conceal fraudulent financial reporting. 3. How assets of the entity could be misappropriated. 4. How the auditor might respond to the susceptibility of material misstatements due to fraud. 11-9 Auditors must inquire whether management has knowledge of any fraud or suspected fraud within the company.

SAS 99 also requires auditors to inquire of the audit committee about its views of the risks of fraud and whether the audit committee has knowledge of any fraud or suspected fraud. If the entity has an internal audit function, the auditor should inquire about internal audit’s views of fraud risks and whether they have performed any procedures to identify or detect fraud during the year. SAS 99 further requires the auditor to make inquiries of others within the entity whose duties lie outside the normal financial reporting lines of responsibility about the existence or suspicion of fraud. 1-10The corporate code of conduct establishes the “tone at the top” of the importance of honesty and integrity and can also provide more specific guidance about permitted and prohibited behavior. Example of items typically addressed in a code of conduct include expectations of general employee conduct, restrictions on conflicts of interest, and limitations on relationships with clients and suppliers. 11-11Management and the board of directors are responsible for setting the “tone at the top” for ethical behavior in the company.

It is important for management to behave with honesty and integrity because this reinforces the importance of these values to employees throughout the organization. 11-12Management has primary responsibility to design and implement antifraud programs and controls to prevent, deter, and detect fraud. The audit committee has primary responsibility to oversee the organization’s financial reporting and internal control processes and to provide oversight of management’s fraud risk assessment process and antifraud programs and controls. 1-13The three auditor responses to fraud are: (1) change the overall conduct of the audit to respond to identified fraud risks; (2) design and perform audit procedures to address identified risks; and (3) perform procedures to address the risk of management override of controls. 11-14Auditors are required to take three actions to address potential management override of controls: (1) examine journal entries and other adjustments for evidence of possible misstatements due to fraud; (2) review accounting estimates for biases; and (3) evaluate the business rationale for significant unusual transactions. 1-15Three main techniques use to manipulate revenue include: (1) recording of fictitious revenue; (2) premature revenue recognition including techniques such as bill-and-hold sales and channel stuffing; and (3) manipulation of adjustments to revenue such as sales returns and allowance and other contra accounts. 11-16Cash register receipts are particularly susceptible to theft. The notice “your meal is free if we fail to give you a receipt” is designed to ensure that every customer is given a receipt and all sales are entered into the register, establish accountability for the sale. 1-17The three types of inquiry are informational, assessment, and interrogative. Auditors use informational inquiry to obtain information about facts and details that the auditor does not have. For example, if the auditor suspects financial statement fraud involving improper revenue recognition, the auditor may inquire of management as to revenue recognition policies. The auditor uses assessment inquiry to corroborate or contradict prior information.

In the previous example, the auditor may attempt to corroborate the information obtained from management by making assessment inquiries of individuals in accounts receivable and shipping. Interrogative inquiry is used to determine if the interviewee is being deceptive or purposefully omitting disclosure of key knowledge of facts, events, or circumstances. For example, a senior member of the audit team might make interrogative inquiries of management or other personnel about key elements of the fraud where earlier responses were contradictory or evasive. 1-18When making inquiries of a deceitful individual, three examples of verbal cues are frequent rephrasing of the question, filler terms such as “well” or “to tell the truth,” and forgetfulness or acknowledgements of nervousness. Three examples of nonverbal cues by the individual are creating physical barriers by blocking their mouth, leaning away from the auditor, and signs of stress such as sweating or fidgeting. 11-19When the auditor suspects that fraud may be present, SAS 99 requires the auditor to obtain additional evidence to determine whether material fraud has occurred.

SAS 99 also requires the auditor to consider the implications for other aspects of the audit. When the auditor determines that fraud may be present, SAS 99 requires the auditor to discuss the matter and audit approach for further investigation with an appropriate level of management that is at least one level above those involved, and with senior management and the audit committee, even if the matter might be considered inconsequential. For public company auditors, the discovery of fraud of any magnitude by senior management is at least a significant deficiency and may be a material weakness in internal control over financial reporting.

This includes fraud by senior management that results in even immaterial misstatements. If the public company auditor decides the fraud is a material weakness, the auditor’s report on internal control over financial reporting will contain an adverse opinion. ¦Multiple Choice Questions From CPA Examinations 11-20a. (3)b. (4)c. (1)d. (2) 11-21a. (1)b. (4) 11-22a. (1)b. (1)c. (1) ¦Discussion Questions and Problems 11-23 InformationFraud Condition 1. Management has a strong interest in employing inappropriate means to minimize reported earnings for tax-motivated reasons.

Incentives/Pressures 2. Assets and revenues are based on significant estimates that involve subjective judgments and uncertainties that are hard to corroborate. Opportunities 3. The company is marginally able to meet exchange listing and debt covenant requirements. Incentives/Pressures 4. Significant operations are located and conducted across international borders in jurisdictions where differing business environments and cultures exist. Opportunities 5. There are recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality.

Attitudes/Rationalization 6. The company’s financial performance is threatened by a high degree of competition and market saturation. Incentives/Pressures 11-24 a. Management fraud is often called fraudulent financial reporting, and is the intentional misstatement or omission of amounts or disclosures by management with the intent to deceive users. In contrast, defalcations, which are also called misappropriation of assets, involve theft of an entity’s assets, and normally involve employees and others below the management level. b. The auditor’s responsibility to detect management fraud s the same as for other errors that affect the financial statement. The auditor should design the audit to obtain reasonable assurance that material misstatements in the financial statements due to errors or fraud are detected. c. The auditor should evaluate the potential for management fraud using the fraud triangle of incentives/pressures, opportunities, and attitudes/ rationalizations. ?Incentives/pressures – Auditors should evaluate incentives and pressures that management or other employees may have to misstate financial statements, including: 1-24 (continued) 1. Declines in the financial stability or profitability of the company due to economic, industry, or company operating conditions. 2. Pressure to meet debt repayment or debt covenant terms. 3. Net worth of managers or directors is materially threatened by financial performance. ?Opportunities – Circumstances provide an opportunity for management to misstate financial statements, such as: 1. Financial statements include significant accounting estimates that are difficult to verify. 2. Ineffective board of director or audit committee oversight. . High turnover in accounting personnel or ineffective accounting, internal auditing, or IT staff. ?Attitudes/Rationalizations – An attitude, character, or set of values exist that allows management to rationalize committing a dishonest act. 1. Inappropriate or ineffective communication of entity values. 2. History of violations of securities laws or other laws and regulations. 3. Aggressive or unrealistic management goals or forecasts. d. There are potentially many factors that should heighten an auditor’s concern about the existence of management fraud.

The factors (1) of an intended public placement of securities, and (2) management compensation dependent on operating results are both factors that affect incentives to manipulate financial statements. The auditor should be alert for other incentives, such as the existence of debt covenants or planned use of stock to acquire another company that may provide incentives to manipulate the financial statements. The third factor of weak internal control reflects both an opportunity to misstatement financial statements, and an attitude that allows rationalization of actions to misstate the financial statements.

As additional examples, the auditor should be alert to the potential to use accounting estimates or discretion over the timing of revenues to misstate financial statements. The auditor should also consider the attitude of management, and whether they are overly aggressive or have previously violated securities laws or other regulations. In addition to the risk factors from the fraud triangle, the auditor should consider other signals of the potential existence of management fraud. These signals may include unusual changes in ratios or other performance measures, as well as inquiries of management and communication amount the audit team. 1-25 a. DEFICIENCYRECOMMENDATION 1. There is no basis for establishing the documentation of the number of paying patrons. Prenumbered admission tickets should be issued upon payment of the admission fee. 2. There is no segregation of duties between persons responsible for collecting admission fees and persons responsible for authorizing admission. One clerk (hereafter referred to as the cash receipts clerk) should collect admission fees and issue prenumbered tickets. The other clerk (hereafter referred to as the admission clerk) should authorize admission upon receipt of the ticket or proof of membership. . An independent count of paying patrons is not made. The admission clerk should retain a portion of the prenumbered admission ticket (admission ticket stub). 4. There is no proof of accuracy of amounts collected by the clerks. Admission ticket stubs should be reconciled with cash collected by the treasurer each day. 5. Cash receipts records are not promptly prepared. The cash receipts should be recorded by the cash receipts clerk daily on a permanent record that will serve as the first record of accountability. 6. Cash receipts are not promptly deposited. Cash should not be left undeposited for a week.

Cash should be deposited at least once each day. 7. There is no proof of the accuracy of amounts deposited. Authenticated deposit slips should be compared with daily cash receipts records. Discrepancies should be promptly investigated and resolved. In addition, the treasurer should establish policy that includes a review of cash receipts. 8. There is no record of the internal accountability for cash. The treasurer should issue a signed receipt for all proceeds received from the cash receipts clerk. These receipts should be maintained and should be periodically checked against cash receipts and deposit records. . All of the deficiencies increase the likelihood of misappropriation of assets, by allowing individuals access to cash receipts or failing to maintain adequate records to establish accountability for cash receipts. c. The deficiencies have less of an effect on the likelihood of fraudulent financial reporting than they do for misappropriation of assets. The first four deficiencies increase the likelihood of fraudulent financial reporting for reported revenues due to the lack of adequate records to establish the number of patrons. 11-26 1. a. Error b.

Internal verification of invoice preparation and posting by an independent person. c. Test clerical accuracy of sales invoices. 2. a. Error b. Sales invoices are prenumbered, properly accoun¬ted for in the sales journal, and a notation on the invoice is made of entry into the sales journal. c. Account for numerical sequence of invoices recorded in the sales journal, watching for duplicates. Confirm accounts receivable at year-end. 3. a. Fraud. b. All payments from customers should be in the form of a check payable to the company. Monthly statements should be sent to all customers. c.

Trace from recorded sales transactions to cash receipts for those sales; confirm accounts receivable balances at year-end. 4. a. Fraud. b. The prelisting of cash receipts should be compared to the postings in the accounts receivable master file and to the validated bank deposit slip. c. Trace cash received from prelisting to cash receipts journal. Confirm accounts receivable. 5. a. Error. b. Use of prenumbered bills of lading that are periodically accounted for. c. Trace a sequence of prenumbered bills of lading to recorded sales transactions. Confirm accounts receivable at year-end. 6. a. Error. b.

No merchandise may leave the plant without the preparation of a prenumbered bill of lading. c. Trace credit entries in the perpetual inventory records to bills of lading and the sales journal. Confirm accounts receivable at year-end. 7. a. Error. b. Internal review and verification by an indepen¬dent person. c. Test accuracy of invoice classification. 8. a. Error b. Online sales are supported by shipping documents and approved online customer orders. c. Trace sales journal or listing entries to supporting documents for online sales, including sales invoices, shipping documents, sale orders, and customer orders. 1-27a. The lack of separation of duties was the major deficiency that permitted the fraud for Appliance Repair and Service Company. Gyders has responsibility for opening mail, prelisting cash, updating accounts receivable, and authorizing sales allowances and write-offs for uncollectible accounts. It is easy for Gyders to take the cash before it is prelisted and to charge off an accounts receivable as a sales allowance or as a bad debt. b. The benefit of prelisting cash is to immediately document cash receipts at the time that they are received by the company.

Assuming all cash is included on the prelisting, it is then easy for someone to trace from the prelisting to the cash receipts journal and deposits. Furthermore, if a dispute arises with a customer, it is easy to trace to the prelisting and determine when the cash was actually received. The prelisting should be prepared by a competent person who has no significant responsibilities for accounting functions. The person should not be in a position to withhold the recording of sales, adjust accounts receivable or sales for credits, or adjust accounts receivable for sales returns and allowances or bad debts. c.

Subsequent to the prelisting of cash, it is desirable for an independent person to trace from the prelisting to the bank statement to verify that all amounts were deposited. This can be done by anyone independent of whoever does the prelisting, or prepares or makes the deposit. d. A general rule that should be followed for depositing cash is that it should be deposited as quickly as possible after it is received, and handled by as few people as possible. It is, ideally, the person receiving the cash that should prepare the prelisting and prepare the deposit immediately afterward. That person should then deposit the cash in the bank.

Any uninten¬tional errors in the preparation of the bank statement should be discovered by the bank. The authenticated duplicate deposit slip should be given to the accounting department who would subse¬quently compare the total to the prelisting. When an independent person prepares the bank reconciliation, there should also be a comparison of the prelisting to the totals deposited in the bank. Any money taken before the prelisting should be uncovered by the accounting department when they send out monthly statements to customers. Customers are likely to complain if they are billed for sales for which they have already paid. 1-28 a. DEFICIENCIESLIKELY MISSTATEMENTS 1. The foreman has the ability to hire employees and enter their names into the pay system with no other approval. Nonexistent or incompetent employees may be hired at the foreman’s option. 2. The foreman may make changes to salary rates without approval of company management. Employees or nonexistent employees may be paid at rates that are higher than their skill warrants. 3. No investigation of new employees to determine background experience and dependability is performed. Dishonest or unqualified employees may be hired. 4. No control exists over time cards and the completion thereof.

Employees may report and be paid for time that they did not work. 5. No review or internal verification of the amount on the payroll checks is performed. Misstatements made by the payroll clerks in favor of employees would likely not be discovered. 6. Payroll checks are not prenumbered or controlled by the payroll clerks. The chief accountant could prepare, sign, and cash an extra payroll check without detection. b. Deficiencies 1, 2, 4, 5, and 6 increase the likelihood of fraud involving misappropriation of assets. Fraud involving misappropriation of assets is relatively common for payroll, although the amounts are often not material.

Fraudulent financial reporting involving payroll is less likely. 11-29a. The auditor must conduct the audit to detect errors and fraud, including embezzlement, that are material to the financial statements. It is more difficult to discover embezzlements than most types of errors, but the auditor still has significant responsibility. In this situation, the deficiencies in internal control are such that it should alert the auditor to the potential for fraud. On the other hand, the fraud may be immaterial and therefore not be of major concern.

The auditor of a public company must also consider the impact of noted deficiencies when issuing the auditor’s report on internal control over financial reporting. When noted deficiencies are considered to be material weaknesses, whether individually or combined with other deficiencies, the auditor’s report must be modified to reflect the presence of material weaknesses. b. The following deficiencies in internal control exist: 1. The person who reconciles the bank account does not compare payees on checks to the cash disbursements journal. 2. The president signs blank checks, thus providing no control over expenditures. 3.

No one checks invoices to determine that they are cancelled when paid. 11-29 (continued) c. To uncover the fraud, the auditor could perform the following procedures: 1. Comparison of payee on checks to cash disbursements journal. 2. Follow up all outstanding checks that did not clear the bank during the engagement until they clear the bank. Compare payee to cash disbursements journal. 11-30 a. a. FRAUD? b. TYPE OF FRAUD 1. YesFraudulent financial reporting 2. YesMisappropriation of assets 3. YesFraudulent financial reporting 4. YesMisappropriation of assets 5. YesFraudulent financial reporting 6. YesMisappropriation of assets 7.

No *N/A * Fraud involves intent. The circumstances suggest that there was no intent on the part of Franklin to be deceptive. If the purpose of omitting the footnote was to deceive the bank, then this case would represent fraudulent financial reporting. ¦Case 11-31 a. There are many fraud risk factors indicated in the dialogue. Among the fraud risk factors are the following: ? A significant portion of Mint’s compensation is represented by bonuses and stock options. Although this arrangement has been approved by SCS’s Board of Directors, this may be a motivation for Mint, the new CEO, to engage in fraudulent financial reporting. Mint’s statement to the stock analysts that SCS’s earnings would increase by 30% next year may be both an unduly aggressive and unrealistic forecast. That forecast may tempt Mint to intentionally misstate certain ending balances this year that would increase the profitability of the next year. 11-31(continued) ?SCS’s audit committee may not be sufficiently objective because Green, the chair of the audit committee, hired Mint, the new CEO, and they have been best friends for years. ?One individual, Mint, appears to dominate management without any compensating controls.

Mint seems to be making all the important decisions without any apparent input from other members of management or resistance from the Board of Directors. ?There were frequent disputes between Brown, the prior CEO, who like Mint apparently dominated management and the Board of Directors, and Jones, the predecessor auditor. This fact may indicate that an environment exists in which management will be reluctant to make any changes that Kent suggests. ?Management seems satisfied with an understaffed and ineffective internal audit department. This situation displays an inappropriate attitude regarding the internal control environment. Management has failed to properly monitor and correct a significant deficiency in its internal control—the lack of segregation of duties in cash disbursements. This disregard for the control environment is also a risk factor. ?Information about anticipated future layoffs has spread among the employees. This information may cause an increase in the risk of material misstatement arising from the misappropriation of assets by dissatisfied employees. b. Kent has many misconceptions regarding the consideration of fraud in the audit of SCS’s financial statements that are contained in the dialogue. Among Kent’s misconceptions are the following: ?

Kent states that the auditor does not have specific duties regarding fraud. In fact, an auditor has a responsibility to specifically assess the risk of material misstatement due to fraud and to consider that assessment in designing the audit procedures to be performed. ?Kent is not concerned about Mint’s employment contract. Kent should be concerned about a CEO’s contract that is based primarily on bonuses and stock options because such an arrangement may indicate a motivation for management to engage in fraudulent financial reporting. ?Kent does not think that Mint’s forecast for 2006 has an effect on the financial statement audit for 2005.

However, Kent should consider the possibility that Mint may intentionally misstate the 2005 ending balances to increase the reported profit in 2006. ?Kent believes the audit programs are fine as is. Actually, Kent should modify the audit programs because of the many risk factors that are present in the SCS audit. ?Kent is not concerned that the internal audit department is ineffective and understaffed. In fact, Kent should be concerned that SCS has permitted this situation to continue because it represents a risk factor relating to misstatements arising from fraudulent financial reporting and/or the misappropriation of assets. 1-31 (continued) ?Kent states that an auditor provides no assurances about fraud because that is management’s job. In fact, an auditor has a responsibility to plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. ?Kent is not concerned that the prior year’s material weakness in internal control has not been corrected. However, Kent should be concerned that the lack of segregation of duties in the cash disbursements department represents a risk factor relating to misstatements arising from the misappropriation of assets.

If the client was a publicly traded company, the presence of an uncorrected material weakness would significantly affect the auditor’s report on internal control over financial reporting. ?Kent does not believe the rumors about big layoffs in the next month have an effect on audit planning. In planning the audit, Kent should consider this a risk factor because it may cause an increase in the risk of material misstatement arising from misappropriation of assets by dissatisfied employees. c.

SAS 99 requires that auditors document the following matters related to the auditor’s consideration of material misstatements due to fraud: ? The discussion among engagement team personnel in planning the audit about the susceptibility of the entity’s financial statements to material fraud. ?Procedures performed to obtain information necessary to identify and assess the risks of material fraud. ?Specific risks of material fraud that were identified, and a description of the auditor’s response to those risks. ?Reasons supporting a conclusion that there is not a significant risk of aterial improper revenue recognition. ?Results of the procedures performed to address the risk of management override of controls. ?Other conditions and analytical relationships that indicated that additional auditing procedures or other responses were required, and the actions taken by the auditor. ?The nature of communications about fraud made to management, the audit committee, or others. After fraud risks are identified and documented, the auditor should evaluate factors that reduce fraud risk. The auditor should then develop appropriate responses to the risk of fraud. Internet Problem 11-1: Fraud Best Practices The American Institute of Certified Public Accountants has developed a comprehensive Web site devoted to fraud and corporate responsibility. A wide range of resources are available including the prevention, detection and investigation of fraud, corporate governance matters, and a link to the Audit Committee Effectiveness Center [www. aicpa. org/audcommctr/homepage. htm]. Visit this site and answer the following questions. 1. What is the Audit Committee Matching System?

Answer: The Audit Committee Matching System is a tool developed by the AICPA to serve two purposes. First, it affords opportunities to the association’s members to utilize their expertise and serve on boards of directors. Second, it provides a public service by offering a list of qualified, credentialed candidates to serve on boards of directors and presumably the audit committees of those boards thereby increasing the pool of qualified and interested applicants for the audit committee. 2. Read “Peer Review of CPA Firms: An Overview” to answer the following questions. Hint: The article may be found under “Getting Started – Engaging the Independent Auditors” after clicking on “Independent Auditors and the Audit Committee. ”) a. What are the three types of peer review reports? Answer: There are three types of peer review reports: unmodified, modified, and adverse. 1. An unmodified report means the reviewed firm’s system of quality control has been designed to meet the requirements of the quality control standards for an accounting and auditing practice and the system was being complied with during the peer review year to provide the firm with reasonable assurance of complying with professional standards. . A modified report means the design of the firm’s system of quality control created a condition in which the firm did not have reasonable assurance of complying with professional standards or that the firm’s degree of compliance with its quality control policies and procedures did not provide it with reasonable assurance of complying with professional standards. 3.

An adverse report means there are significant deficiencies in the design of the firm’s system of quality control, pervasive instances of noncompliance with the system as a whole, or both, resulting in several material failures to adhere to professional standards on engagements. 11-1 (continued) b. What are the three common misconceptions about peer review mentioned in the article? Answer: The three common misconceptions are: 1. Fiction: A peer review evaluates every engagement audited by a CPA firm.

Fact: A peer review is performed using a risk-based approach. A peer reviewer must review enough engagements to obtain reasonable assurance that the reviewed firm is complying with its quality control policies and procedures. Therefore, it is possible that the review would not disclose all weaknesses in the system of quality control or all instances of lack of compliance with it. 2. Fiction: An unmodified report provides assurance with respect to every engagement conducted by the firm.

Fact: Every engagement conducted by a firm is not included in the scope of a peer review nor is every aspect of each engagement reviewed. The peer review includes reviewing all key areas of engagements selected. 3. Fiction. If a firm receives a letter of comments, its system of quality control is inadequate. Fact: The criterion for including an item in the letter of comments is whether the item resulted in a condition being created in which there was more than a remote possibility that the firm would not comply with professional standards on accounting and auditing engagements.

Because this is a very low threshold, most peer reviews result in the issuance of a letter of comments. c. Who must conduct peer reviews of audit firms that audit public companies? Answer: Staff of the Public Company Accounting Oversight Board. (Note: Internet problems address current issues using Internet sources. Because Internet sites are subject to change, Internet problems and solutions may change. Current information on Internet problems is available at www. prenhall. com/arens. )

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