Deck 11: Financial Statement Fraud

Question 1

Your audit team working with a newly acquired 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

Answer 1

C

Question 2

There has been an auditor change at Company X.Which of the following situations may NOT signal a potential fraud problem?

A)Failure to pay an audit fee
B)Auditee believing that the auditor's fees are too high
C)Suspected fraud or other problems by the auditor
D)Auditor-auditee disagreement

Answer 2

B

Question 3

Your firm has just acquired a new audit client.The new client is highly leveraged with borrowing from several institutions.It is planning to expand the business by obtaining additional debt finance in the near future.Based on these facts,which one of the following should be most carefully examined?

A)Transactions that result in healthy revenues
B)Large market capitalization
C)Loans and other financing transactions between related entities
D)Dividend paid out in the previous year

Answer 3

C

Question 4

According to study of financial statement frauds by the Committee of Sponsoring Organizations (COSO),the average fraud lasts for how many months?

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

Question 5

Which of the following is a finding of the Treadway Commission?

A)Financial statement frauds occur very often,the average fraud lasts about two years.
B)The CEO perpetrates the fraud in 72% of the cases.
C)While financial statement frauds occur infrequently,they are extremely costly.
D)Financial statement fraud occurs mostly in companies that are listed.

Question 6

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 whether significant short selling of the company's stock has occurred.
C)it can uncover the fraudulent transactions from special purpose entities.
D)it may help in raising additional funds from the financial institutions.

Question 7

While generally accepted accounting principles do allow flexibility,standards of _________,________,and ________ must always prevail in the financial statements.

A)subjectivity;integrity;validation
B)objectivity;integrity;judgement
C)recording;reporting;accounting
D)quality;excellence;and judgement

Question 8

Company XYZ had a long-standing relationship with a leading law firm.In fact,the law firm's business with this company was one of its most profitable relationships.If the law firm decides that it no longer wants to conduct business with the company,this is:

A)indicative that the company might have a lot of customer law suits against it.
B)not any sort of meaningful indicator of fraud activity.
C)a large cause for concern that financial statement fraud may be occurring.
D)an indication that the client has likely outgrown the law firm.

Question 9

According to study of financial statement frauds by the Committee of Sponsoring Organizations (COSO),who is the most common perpetrator of financial statement fraud?

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

Question 10

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 11

The study done by the Committee of Sponsoring Organizations (COSO)on financial statement frauds that occurred during the period from 1987-1997 had many key findings.Which of the following is NOT one among them?

A)Frauds were most commonly perpetrated by improper revenue recognition,overstatement of assets,and understatement of expenses.
B)Most of these firms had audit committees that met at least four times a year.
C)Severe consequences were associated with companies who committed financial statement fraud.
D)Most companies were experiencing net losses or were just holding break-even positions in periods prior to the fraud.

Question 12

Identify an example of a perceived pressure that can motivate financial statement fraud.

A)The ability to obfuscate the fraud behind complex transactions
B)Failure to meet Wall Street's earnings expectations
C)Rationalizing that all companies use aggressive accounting practices
D)A weak board of directors

Question 13

Which of the following related party transactions need to most carefully examined for fraud?

A)Transactions that generate operating income
B)Transactions that appear realistic
C)Absence of loans or other financing transactions between related entities
D)Transactions that result in goodwill being recognized in the financial statements

Question 14

Should nonfinancial indicators be used for assessing fraud risk? Why or why not?

A)No.A company's financial statement data need not always be consistent with its nonfinancial measures.
B)Yes.Management can more easily manipulate financial numbers but finds it harder to keep all the nonfinancial information consistent with the financial information.
C)No.Nonfinancial measures are indicative of physical assets alone.
D)Yes.Management attempts to commit fraud first show up in these indicators.Financial statement fraud is an attempt to cover up those attempts.

Question 15

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)any company,as the probability of a fraud does not change with the size of a company.

Question 16

Which of the following is an example of a perceived opportunity that can lead to financial statement fraud?

A)Inability to compete with other companies
B)Independent audit and a strong board of directors
C)Thinking that fraud is good for the company
D)Inadequate internal controls

Question 17

Which of the following organizational characteristics is an indicator of a possible fraud?

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 18

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)Stable dividend payout ratio
C)Increased hiring of qualified employees by the company
D)Addition of an independent member on the board

Question 19

Which of the following statements 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 20

Which of the following is NOT a kind of questions that should be asked in order to understand the exposure to management fraud?

A)Is a legitimate business purpose apparent for each separate entity of the business?
B)Have significant recent changes occurred in the nature of the organization?
C)Are the accounting and information technology staff and organization effective?
D)How many old employees are there in the organization?

Question 21

Which of the following is NOT one of the components of the fraud exposure rectangle?

A)Accounting system controls
B)Management and directors
C)Financial results and operating characteristics
D)Organization and its industry

Question 22

When engaged in _____,the auditor simply considers his or her own incentives,such as audit fees,sampling costs,and penalties.

A)Higher-order reasoning
B)Zero-order reasoning
C)First-order reasoning
D)Deductive reasoning

Question 23

_____ means that the auditor considers conditions that directly affect the auditee.

A)Low-order reasoning
B)Zero-order reasoning
C)Deductive reasoning
D)First-order reasoning

Question 24

_______ is a performance evaluation method that focuses on both financial and nonfinancial indicators of performance such as customer satisfaction.

A)360 degree survey
B)Critical incidents method
C)Balanced scorecard
D)Pareto chart

Question 25

What are special purpose entities (SPEs)?

A)Fictitious organizations formed in order to perpetrate a financial statement fraud.
B)Business interests formed solely in order to accomplish some specific task or tasks.
C)Bodies formed to establish audit reporting standards and rules.
D)Independent audit boards set up to ensure that the financial statements are verified.

Question 26

Which types of questions should be asked about a company's relationship with financial institutions?

A)Is a significant part of the company's income or revenues derived from one or two large transactions?
B)Has management placed unreasonable demands on the auditor,including unreasonable time constraints?
C)Has significant "short selling" of the company's stock occurred? If so,for what reasons?
D)Is the organization highly leveraged through bank or other loans?

Question 27

______ refers to the ability to anticipate a fraud perpetrator's likely method of concealing a fraud.

A)Zero-order reasoning
B)Deductive reasoning
C)Strategic reasoning
D)Low-order reasoning

Question 28

What is the meaning of "short sell"?

A)Buy shares from a brokerage firm and enter into a forward transaction to sell the shares at today's price on a future date.
B)Sell the shares at today's price to an investor and enter into an option agreement to buy the shares back in near future.
C)Buy shares from one brokerage firm and sell the shares to another brokerage firm with a view to make quick money.
D)Borrow shares from a brokerage and sell the shares at today's price with the intention to repay the borrowed stock they sold at some future time when the stock is trading for a lower price.

Question 29

Which of the following observations concerning backdating of options is true?

A)It will not result in restatement of financial statements.
B)The extraordinary timing and frequency of occurrences defied statistical probability.
C)There is no concrete evidence that managers gained because of this practice.
D)It is a legal way of compensating managers who perform exceedingly well.

Question 30

10-K forms refer to:

A)the corporate reports filed with the SEC.
B)the tax returns filed with the IRS.
C)the press releases to the newswires.
D)the bankruptcy filing document.

Question 31

______ are the backbone of capitalism and allow investors,lenders,and regulators to measure the performance of a business.

A)Government policies
B)Financial statements
C)Stock prices
D)Credit reports

Question 32

According to the study done by the Securities and Exchange Commission,greatest number of enforcement actions was in the area of ________.

A)improper use of off-balance-sheet arrangements
B)improper expense recognition
C)improper accounting for business combinations
D)improper revenue recognition

Question 33

In this phase of the business cycle,most businesses appear to be highly profitable.

A)Trough
B)Recession
C)Recovery
D)Boom

Question 34

An auditor adjusts the audit plan by introducing unexpected audit procedures in response to what the auditor believes management may be doing to conceal a fraud based on management's strategic reasoning.Which order of reasoning is occurring here?

A)Low-order reasoning
B)Zero-order reasoning
C)Higher-order reasoning
D)First-order reasoning

Question 35

A CEO believes that the company should try to keep the stock price high by manipulating the financial statements to protect its shareholders.Which element of the fraud triangle is discussed here?

A)Perceived opportunity
B)Trauma
C)Rationalization
D)Perceived pressure

Question 36

______ is a practice where the effective dates on stock options are deliberately changed for the purpose of securing extra pay for management.

A)Backtracking
B)LEAP
C)Arbitrage
D)Backdating

Question 37

Which of the following occurs when an auditor and auditee only consider conditions that directly affect themselves but not the other party?

A)Zero-order reasoning
B)Deductive reasoning
C)First-order reasoning
D)Higher-order reasoning

Question 38

Which is a common method of providing executive compensation by allowing top management to purchase stock at a fixed share price?

A)Stock splits
B)Arbitrage
C)Dividends
D)Stock options

Question 39

Which legislation led to the establishment of the Public Company Accounting Oversight Board?

A)Private Securities Litigation Reform Act
B)Sarbanes-Oxley Act
C)Gramm-Leach-Bliley Act
D)Glass-Steagall Act

Question 40

Many financial statement frauds have been perpetrated because:

A)management needed to report high income to support stock prices.
B)management wanted to decrease the total tax payable by the company.
C)management wanted to show artificial losses to employees.
D)management wanted to pay lower dividends to the shareholders.