Fraud Examination Chapter 11 Exam Questions and Complete Solution

Fraud Examination Chapter 11 Exam Questions and Complete Solutions Unlike other types of fraud, financial statement fraud is usually not concealed and is therefore relatively easy to spot - Ans: False Fraud indicators, or red flags, can be caused by fraud or by legitimate, non-fraud factors - Ans: True Without a confession, forged documents, or repeated fraudulent acts that establish a pattern of dishonesty, convicting someone I fraud is often difficult. - Ans: True According to the 1999 and 2010 COSO studies of fraudulent financial reporting, the most common method used to perpetrate financial statement fraud includes overstating liabilities - Ans: False According to the 1999 COSO study, most companies that committed financial statement fraud had no audit committee or had an audit committee that met less than twice a year - Ans: True Michael "Mikey" Monus and Patrick Finn of Phar-Mor used three methods of income statement fraud: account manipulation, overstatement of inventory, and accounting rules manipulations. - Ans: True In identifying management fraud exposures, it is useful to think of the fraud exposure triangle, which includes 1) management and directors, 2) organizations and industry, and 3) relationships with others - Ans: False Financial statement fraud is usually committed by entry-level accountants against an organization - Ans: False In searching for financial statement fraud, the three aspects of directors and members of management that should be known are 1) their backgrounds, 2) their motivations, 3) their influence in making decisions for the organization - Ans: True An organization's relationship with other organizations and individuals is of no interest to a fraud examiner - Ans: False Recording fictitious revenues is one of the most common ways of perpetrating financial statement fraud - Ans: True Most often, the controller or chief financial officer (CFO) of a corporation is the perpetrator of financial statement fraud because of his or her knowledge of accounting and unlimited access to accounts - Ans: False Financial statement fraud, like other types of fraud, is most often committed against an organization instead of on behalf of the organization - Ans: False Most people who commit management fraud are repeat offenders - Ans: False Most financial statement frauds occur in large, historically profitable organizations - Ans: False Zero-order strategic reasoning takes into account the potential actions of others before one decides to act - Ans: False Backdating is a method of dating stock options so that stock option holders can maximize their payout - Ans: True Identifying fraud exposures is one of the most difficult steps in detecting financial statement fraud. - Ans: True Higher-order reasoning is the most challenging of the types of strategic reasoning, but can potentially be the most effective in detecting financial statement fraud - Ans: True Financial statement fraud is usually committed by: A. Executives B. Managers C. Stockholders D. Outsiders E. Bother A and B - Ans: E. Both A and B Which officer in a company is most likely to be the perpetrator of financial statement fraud? A. Chief financial officer (CFO) B. Controller C. Chief operating officer (COO) D. Chief executive officer (CEO) - Ans: D. Chief executive officer (CEO) When looking for financial statement fraud, auditors should look for indicators of fraud by: A. Examining financial statements B. Evaluating changes in financial statements C. Examining relationships the company has with other parties D. Examining operating characteristics of the company E. All of the above F. None of the above because auditors don't have a responsibly to find financial state fraud - Ans: E. All of the above The three aspects of management that a fraud examiner needs to be aware of include all of the following except: A. Their backgrounds B. Their motivations C. Their religious convictions D. Their influence in making decisions for the organization - Ans: C. Their religious convictions Which of the following is least likely to be considered a financial reporting fraud symptom, or red flag? A. Grey directors B. Family relationships between directors or officers C. Large increases in accounts receivable with no increase in sales D. Size of the firm - Ans: D. Size of the firm Many indicators of fraud are circumstantial; that is, they can be caused by nonfraud factors. This fact can make convicting someone of fraud difficult. Which of the following types of evidence would be most helpful in proving that someone committed fraud? A. Missing documentation B. A general ledger that is out of balance C. Analytical relationships that don't make sense D. A repeated pattern of similar fraudulent acts - Ans: D. A repeated pattern of similar fraudulent acts In the Par-Mor fraud case, several different methods were used for manipulating the financial statements. These included all of the following except: A. Funneling losses into unaudited subsidiaries B. Overstating inventory C. Recognizing revenue that should have been deferred D. Manipulating accounts - Ans: A. Funneling losses into unaudited subsidiaries Most financial statement frauds occur in smaller organizations with simple management structures, rather than in large, historically profitable organizations. This is because: A. It is easier to implement good internal controls in a small organization B. Smaller organizations do not have investors C. Management fraud is more difficult to commit when there is a more formal organizational structure of management D. People in large organizations are more honest - Ans: C. Management fraud is more difficult to commit when there is a more formal organizational structure of management Management fraud is usually committed on behalf of the organization rather than against it. Which of the following would not be a motivation of fraud on behalf of an organization? A. CEO needs a new car B. A highly competitive industry C. Pressure to meet expected earnings D. Restructure debt covenants that can't be met - Ans: A. CEO needs a new car All of the following are indicators of financial statement fraud except: A. Unusually rapid growth of profitability B. Threat of a hostile takeover C. Dependence on one or two products D. Large amounts of available cash - Ans: D. Large amounts of available cash During an audit, an auditor considers the conditions of the auditee and plans the audit accordingly. This is an example of which of the following? A. Zero-order reasoning B. High-order reasoning C. First-order reasoning D. Fraudulent reasoning - Ans: C. First-order reasoning In the context of strategic reasoning, if an auditor only follows the established audit plan and does not consider other factors relating to the auditee, then this is an example of which of the following? A. Zero-order reasoning B. Higher-order reasoning C. First-order reasoning D. Fraudulent reasoning - Ans: A. Zero-order reasoning In recent years, many SEC investigations have taken place on the improper issuance of stock options to corporate executives. These practices increase executive compensation at the expense of shareholders. This practice is known as: A. Backdrafting stock options B. Backdating stock options C. Stock option reversals D. Stock option extensions - Ans: B. Backdating stock options Treadway Commission - Ans: The national commission on Fraudulent Financial Reporting that made recommendations related to financial statement fraud and other matters in 1987 10-ks - Ans: The corporate reports filed with the SEC of companies a person has been affiliated with Backdating - Ans: The practice of deliberately and improperly changing the effective dates on stock options for the purpose of securing extra compensation for the option holders Committee of Sponsoring Organizations (COSO) - Ans: An organization made up of representatives from major accounting organizations that is concerned about internal controls and financial statement fraud Financial Statements - Ans: Reports such as the balance sheet, income statements, and statement of cash flows that summarize the financial status and results of operations of a business entity Securities and Exchange Commission (SEC) - Ans: Governmental organization with responsibility for regulating stock trading and the financial statement and reports of public companies Strategic Reasoning - Ans: The reasoning process involved in the fraud setting where an investigator or auditor attempts to predict how a fraud perpetrator may be responding to likely behavior of the investigator (e.g., concealing the fraud from typical procedures) SEC enforcement releases - Ans: A public document released by SEC when a company commits financial statement fraud or other perceived inappropriate activities Non-financial performance measures - Ans: Statistics and data that are not financial in nature but can be used to assess an organizations performance such as the non-financial measures used in a balanced scorecard zero-order reasoning - Ans: the type of strategic reasoning that occurs when an individual who is interacting with another party (e.g., an auditor interacting with management) only considers the conditions that directly affect themselves but not the other party Higher-order reasoning - Ans: the type of reasoning that occurs when an individual (e.g., an auditor) considers how his/her strategic opponent (e.g., management) is engaging in a level of strategic reasoning that is not zero-order reasoning Fraud exposure rectangle - Ans: 1) management and directors 2) Relationship with others 3) Organization and industry 4) financial results and operational characteristics 3 factors that should be investigated on management - Ans: 1) management backgrounds 2) management motivations 3) management influence Nine factors that create the perfect storm - Ans: 1) a booming economy 2) Decay of morale value 3) misplaced incentives 4) high analysts expectations 5) high debt levels 6) focus on accounting rules rather than principles 7) lack of auditor independence 8) greed 9) educator failures First- order reasoning - Ans: the type of strategic reasoning that occurs when an individual (e.g., an auditor) considers conditions that directly affect his or her strategic opponent (e.g., management) while assuming that the opponent (i.e. the auditee) is engaging in zero-order reasoning