Question

When is a duty to disclose fraud to parties other than the client's senior management and its audit committee most likely to exist?

A. When a line manager rather than a lower-level employee commits the fraudulent act.
B. In response to inquiries from a successor auditor.
C. When the fraud results from misappropriation of assets rather than fraudulent financial reporting.
D. When the amount is material.

Answer 1

A duty to disclose fraud externally arises when management fails to address material misstatements in financial reporting, requiring auditors to act to maintain the integrity of financial statements and protect stakeholder interests.

Step-by-step explanation:

A duty to disclose fraud to parties other than the client's senior management and its audit committee is most likely to exist when the fraud results in financial statements being materially misstated and the management or those charged with governance fail to take appropriate remedial action.

Fraudulent activities, especially material misstatements in financial reporting, can have significant impacts on the users of financial statements, such as investors and creditors.

Therefore, if the entity's management and governance do not address the fraud appropriately, auditors may have a professional and ethical obligation to escalate the issue to external parties, such as regulators or legal authorities, to protect the integrity of the financial reporting process and the interests of the stakeholders.

Therefore, the correct answer is C. When the fraud results from misappropriation of assets rather than fraudulent financial reporting.