Deck 11: Financial Statement Fraud

Question 1

The senior on your audit engagement suspects there might be fraud in the company you are auditing. As such she assigns you, a first year staff, to investigate the financial statements and anything else you feel appropriate and then to report your findings. As part of your investigation will consider which of the following:

A) The financial statements alone
B) Financial statement numbers compared with real-world numbers
C) Company management and their motivations
D) B and C

Answer 1

D
As mentioned, there are four things that should be considered when considering financial statement fraud: 1) Financial statement numbers compared to real-world numbers, 2) Relationships the company has, 3) The industry and competitors and, 4) Financial results and operating characteristics. Both B & C are included in the list

Question 2

Understanding a company's debt or leverage is important for which of the following reasons?

A) It helps in gaining a perspective of management's motivations.
B) It helps in understanding the pressures a company faces.
C) It helps identify opportunities in which the company might commit fraud.
D) B and C
E) All of the above

Answer 2

E
A company's debt or leverage situation is really important because it can indicate a myriad of helpful hints in discovering fraud. It can help one understand the pressures that the company or its directors are facing. Understanding the debt situation can help explain management's motivations and opportunities in which they can commit fraud.

Question 3

Which of the following reasons for an organization to change auditors would not be a concern to a successor auditor or an investor?

A) Failure of the client to pay the auditor
B) Auditee's view that the fees are too high
C) Auditor suspicious of fraud or other problems
D) Auditor-auditee disagreement

Answer 3

B
Failure to pay, disputes over accounting issues, and the auditor's suspicion of fraud are all signals that fraud may be present. They don't indicate that fraud is occurring but might be signals or red flags that should not be overlooked.

Question 4

Your audit team, on a newly acquired audit client, discovers that there has been fraudulent financial reporting for the past 5 years. Who is most likely to have been involved in the fraud?

A) Middle management in positions of trust
B) Disgruntled employees
C) Top management
D) The accountants in charge of preparing the financial statements

Question 5

The termination of an auditor-auditee relationship can be caused by all but which of the following?

A) Failure of the client to pay
B) Auditor-auditee disagreement
C) Auditor's suspicion of fraud
D) State government mandate to break long term audit relationships

Question 6

Assuming your client has had a long-standing relationship with a law firm that has resulted in much profitable business for the law firm as they have advised the client in all areas of its business. If the law firm should decide it no longer wants to conduct business with your client, this should...

A) not be a cause for concern of potential financial statement fraud.
B) be a minor concern that financial statement fraud may be occurring.
C) be a large cause for concern that financial statement fraud may be occurring.
D) indicate that the client has likely outgrown the law firm.

Question 7

Your firm has just acquired a new audit client. The new client is a company that is highly leveraged and has debt with several institutions. The new client is also planning on expanding its business and wants to obtain additional debt financing in the near future. Based on these facts, which one of the following should be most carefully examined?

A) Large transactions that result in revenues and/or income
B) Loans and other financing transactions between related entities
C) Large amounts of goodwill on the balance sheet
D) Recent change in credit policies

Question 8

Gaining an understanding of management is crucial in identifying fraud exposures or opportunities for fraud. Which aspect of management should be investigated?

A) Management compensation plan
B) Management backgrounds
C) Management's ability to influence organizational decision making
D) All of above

Question 9

FS fraud is often perpetrated with the help of real or fictitious organizations. As such, auditors should examine those relationships very closely. What type of a change in relationship poses the greatest risk or evidence of wrong doing?

A) Auditors
B) Lawyer
C) Investors
D) Bank

Question 10

All of the following are true except?

A) The CFO is the most likely executive to orchestrate and commit fraud.
B) Management fraud is usually committed on behalf of an organization rather than against it.
C) The four areas of financial statement fraud that need to be examined in detecting financial statement fraud are management and directors, relationships with others, the organization and financial results and operating characteristics.
D) Financial statements play an important role in keeping U.S. capital markets efficient.

Question 11

Which of the following is true?

A) Most financial statement frauds occur in large historically profitable companies.
B) Most people who commit management fraud are first-time offenders.
C) An active board of directors or audit committee does little to deter fraud.
D) Perpetrating fraud is much easier in an organization with democratic leadership, where the decision making is spread among several individuals

Question 12

Which of the following is important to focus on when trying to detect financial statement fraud?

A) Management and Directors
B) The relationships of the company with other entities
C) Financial Results and Operating Characteristics
D) All of the above

Question 13

Although GAAP does allow for some flexibility, which standards should be maintained in preparing financial statements?

A) Assertiveness
B) Integrity & Objectivity
C) Independence
D) None of the above

Question 14

Which of the following is an auditor's most important area to search for detecting financial statement fraud?

A) Management and the Directors.
B) The Company's relationships with other entities.
C) The financial results and operating characteristics.
D) None of the above.

Question 15

Which of the following is most likely a fraudulent cause for financial statement balances to deviate from an expected result?

A) Lost documents
B) Unexpected changes in economic conditions
C) Manipulation of expenses
D) Accounting errors

Question 16

Which of the following items is NOT true, according to the study done by the Committee of Sponsoring Organizations (COSO)?

A) Frauds were most commonly perpetrated by improper revenue recognition, overstating assets, and understating expenses.
B) The average financial statement fraud period extended over 5 years and the frequency of fraudulent acts was sporadic during the period.
C) Severe consequences were associated with companies who committed financial statement fraud (e.g., Chapter 11 bankruptcy, stock was delisted, lawsuits by stockholders or bondholders).
D) Most companies were experiencing net losses or were just holding break-even positions in periods prior to the fraud. Meaning, many frauds were used to reverse downward spirals or to maintain upward trends.

Question 17

Revenue frauds are perpetrated by:

A) Improperly timing transactions
B) Recording receivables to fictitious customers
C) Overestimating the extent to which the earnings process has been completed
D) All of the above

Question 18

Financial statement fraud, like other fraud, is rarely visible and may be concealed through which of the following?

A) Unintentional errors
B) Collusion
C) Falsified documentation
D) B and C
E
All of the above

Question 19

Frauds are more likely to occur in

A) Large, historically profitable companies
B) Companies with an active board of directors
C) Smaller companies where one or two individuals have almost all control in decision making
D) The probability of a fraud does not change with the size of a company

Question 20

Which of the following balance sheet accounts is not often misstated when a company commits financial statement fraud?

A) Accounts payable
B) Inventory
C) Accumulated Depreciation
D) All of the above are accounts often misstated.

Question 21

Relationships with related parties are heavily investigated for fraud because:

A) They often allow for other then arms-length transactions.
B) Related party transactions usually involve a fictitious organization
C) People outside an organization are more likely crooks
D) Usually the board of directors don't know anything about related party transactions

Question 22

The following characteristic(s) is(are) prevalent in most frauds:

A) The company CEO was the perpetrator
B) The last audit report was a qualified audit opinion
C) The company is listed on the New York Stock Exchange
D) The officers held incompatible positions (CEO and CFO)
E) All of the above

Question 23

Which of the following is a true statement regarding financial statement fraud?

A) Financial statement frauds usually involve the theft of assets.
B) Financial statement frauds are usually detected by independent auditors.
C) Financial statement frauds are usually not costly to organizations.
D) Financial statement frauds are usually committed by the top management of the company.

Question 24

According to the COSO's study of financial statement frauds, what is the average period of a financial statement fraud?

A) 12 months
B) 18 months
C) 24 months
D) 30 months

Question 25

Examining a company's relationships with other individuals and entities can reveal important information about financial statement fraud. Identify the piece of information that is CORRECTLY linked to its source.

A) Examining relationships with financial institutions will show whether there has been significant "short selling" of the company's stock.
B) Examining relationships with related parties will show whether there are unusual transactions that significantly improve the company's reported financial performance.
C) Examining a company's relationships with its lawyers will show whether management is able to unduly influence the selection of accounting principles and the determination of significant estimates.
D) Examining relationships with regulatory bodies will show whether the company has recently changed legal counsel.

Question 26

In addition to changes in financial statements, which of the following can indicate financial statement fraud has occurred?

A) Information in the footnotes to the financial statements.
B) Dividend payout ratios.
C) Management's discussion and analysis.
D) Auditor reports.

Question 27

Lifestyle changes are usually not factors in detecting

A) investment scams.
B) kickback schemes.
C) bankruptcy fraud.
D) financial statement fraud.

Question 28

Which of the following is not part of the fraud exposure rectangle?

A) Accounting system controls
B) Management and Directors
C) Financial results and operating characteristics
D) The organization and its industry
E) All of the above are parts of the fraud exposure rectangle

Question 29

Understanding a company's relationships with financial institutions and bondholders is important because

A) it can indicate the extent to which the company is leveraged.
B) it can reveal how much investors will scrutinize management.
C) it can show fraudulent transactions from special purpose entities.
D) All of the above.

Question 30

Which of the following is not a common red flag for financial statement fraud?

A) Missing documents
B) Previous net losses
C) Out-of-balance general ledger
D) Unexpected analytical relationships

Question 31

When focusing on management and directors, all of the following areas should be investigated except:

A) Their backgrounds
B) Their motives
C) Their influence in organizational decision making
D) All of the above should be investigated

Question 32

Fraudulent related-party transactions are discovered by doing the following:

A) Examining large or unusual transactions.
B) Looking under the "fraudulent related-party transactions" in the notes to the financials.
C) Examining the actual existence of physical assets.
D) Examining the backgrounds of managers/board members for criminal records.

Question 33

The background of both management and the directors is investigated during the detection of fraud in a company because:

A) Managers often commit financial statement fraud when they fall on hard times in order to cover their bills.
B) Financial statement fraud is like gambling, once you start you get addicted easily.
C) Individuals high up in the company defraud on behalf of the company as opposed to against the organization
D) Management and directors' backgrounds are not usually investigated during the detection of fraud in a company.

Question 34

According to the COSO's study of financial statement frauds, who is the most common perpetrator of financial statement fraud?

A) Chief Executive Officer
B) Chief Financial Officer
C) Chief Operating Officer
D) Controller

Question 35

Which area do auditors tend to focus on almost entirely when searching for financial statement fraud?

A) Management and directors
B) The company's relationship with other entities
C) The organization and its industry
D) Financial results

Question 36

Financial Statement fraud is usually committed by

A) Entry level accountants
B) Sophisticated lawyers
C) Middle management employees
D) Upper management

Question 37

Which of the following organizational characteristics is a possible fraud red flag:

A) A board of directors comprised mainly of outsiders.
B) An independent internal audit department.
C) An audit committee comprised mainly of insiders.
D) An overstaffed accounting department.

Question 38

Which of the following is not a common way that financial statement fraud is perpetrated?

A) Improper revenue recognition
B) Overstating of assets
C) Understating expenses
D) Overstating liabilities

Question 39

In which of the following situations is fraud most likely to occur?

A) Large companies with democratic leadership
B) Large companies with autocratic leadership
C) Small companies with democratic leadership
D) Small companies with autocratic leadership