CFE-Financial Transactions and Fraud
Schemes Exam UPDATED ACTUAL
QUESTIONS AND CORRECT ANSWERS
Statement of changes in owners' equity - CORRECT ANSWER details the changes in the total
owners' equity amount listed on the balance sheet
-it shows how the amounts on the income statement flow through to the balance sheet
--it acts as the connecting link between the two statements. The balance of the owners' equity at the
beginning of the year is the starting point for the statement. The transactions that affect owners' equity
are listed next and are added together. The result is added to (or subtracted from, if negative) the
beginning-of-the-year balance, which provides the end-of-the-year balance for total owners' equity.
Balance sheet or statement of financial position - CORRECT ANSWER a "snapshot" of a
company's financial situation at a specific point in time, generally the last day of the accounting
period
-an expansion of the accounting equation, Assets = Liabilities + Owners' Equity
Assets are the resources owned by a company.
-presented on the balance sheet in order of liquidity (i.e., how soon they are expected to be converted
to cash).
-in a financial statement fraud scheme, the balance sheet is manipulated to appear stronger by
overstating assets and/or understating liabilities.
-Current assets: cash or other liquid assets that are expected to be converted to cash, sold, or used up,
usually within a year or less.
--include: cash, accounts receivable, inventory, supplies, and prepaid expenses
-long-term assets: assets that will not be converted to cash in the near future, such as fixed assets and
intangible assets
-fixed assets: presented net of accumulated depreciation
--an amount that represents the cumulative expense taken for wear-and-tear on a company's property.
Liabilities are presented in order of maturity
-current liabilities: obligations that are expected to be paid within one year
--accounts payable (the amount owed to vendors by a company for purchases on credit)
,--accrued expenses (e.g., taxes payable or salaries payable)
--portion of long-term debts due within the next year
-long-term liabilities: not due for more than a year
--bonds, notes, and mortgages payable
Includes:
-Notes payable, current assets, retained earnings, and accumulated depreciation can all be found on
the balance sheet.
Matching principle - CORRECT ANSWER requires that expenses be recorded in the same
accounting period as the revenues they help generate.
-Estimates, accruals, and allocations are often needed to meet this requirement.
-When a sale is recorded, the appropriate charges for cost of goods sold, or other expenses directly
corresponding to the sale, should be recorded in the same accounting period.
Gross margin, or gross profit - CORRECT ANSWER Two basic types of accounts are reported
on the income statement—revenues and expenses.
Revenues represent amounts received from the sale of goods or services during the accounting period.
-Most companies present net sales as the first line item on the income statement
-net means that the amount is the company's total sales minus any sales refunds, returns, discounts, or
allowances.
Net Sales = Sales - sales refunds, returns, discounts, or allowances
From net sales, an expense titled cost of goods sold or cost of sales is deducted.
-this expense denotes the amount a company spent (in past, present, and/or future accounting periods)
to produce the goods or services that were sold during the current period.
The difference between net sales and cost of goods sold is called gross margin, or gross profit, which
represents the amount left over from sales to pay the company's operating expenses.
Gross Margin = Net Sales - Cost of Goods Sold
,Revenue recognition principle - CORRECT ANSWER revenue is recognized or recorded when
it becomes realized or realizable, and earned.
-revenue should not be recognized for work that is to be performed in subsequent accounting periods,
even though the work might currently be under contract.
-revenue should be recognized in the period in which the work is performed
Conservatism constraint - CORRECT ANSWER requires that when there is any doubt, one
should avoid overstating assets and income
Principle's intention is to provide a reasonable guideline in a questionable situation
-ex: the use of the lower of cost or market rule as it relates to inventory valuation
If a company's financial statements intentionally violate the principal, they could be fraudulent.
Accounting equation - CORRECT ANSWER Assets = Liabilities + Owners' Equity
-is the basis for all double-entry accounting
Asset (e.g., cash) is stolen, the equation can be balanced by:
- increasing another asset
-reducing a liability
-reducing an owners' equity account
-reducing revenues (and thus retained earnings)
- creating an expense (and thus reducing retained earnings)
Removes a liability, the equation can be balanced by:
- decreasing an asset
-increasing a different liability
-increasing an owners' equity account
-increasing revenues (and thus retained earnings)
-reducing an expense (and thus increasing retained earnings)
, End of fiscal Year closing - CORRECT ANSWER The accounts reflected on the income
statement are temporary; at the end of each fiscal year, they are reduced to a zero balance (closed),
with the resulting net income (or loss) added to (or subtracted from) retained earnings on the balance
sheet.
When to deviate from generally accepted accounting principles (GAAP) - CORRECT ANSWER
a matter of professional judgment; there is no clear-cut set of circumstances that justify such a
departure.
Departures from GAAP can be justified in the following circumstances:
• It is common practice in the entity's industry for a transaction to be reported a particular way.
• The substance of the transaction is better reflected (and, therefore, the financial statements are more
fairly presented) by not strictly following GAAP.
• If a transaction is considered immaterial (i.e., it would not affect a decision made by a prudent reader
of the financial statements), then it need not be reported.
• There is concern that assets or income would be overstated (the conservatism constraint requires that
when there is any doubt, one should avoid overstating assets and income).
• The results of departure appear reasonable under the circumstances, especially when strict adherence
to GAAP will produce unreasonable results and the departure is properly disclosed.
The fact that complying with GAAP would be more expensive or would make the financial statements
look weaker is not a reason
Double-entry accounting - CORRECT ANSWER Every transaction recorded in the accounting
records will have both a debit and a credit
-The debit side of an entry will always equal the credit side so that the accounting equation remains in
balance.
Entries to the left side of an account are referred to as debits, and entries to the right side of an
account are referred to as credits.
Asset and expense accounts are increased with debits and decreased with credit
Liabilities, owners' equity, and revenue accounts are increased with credits and decreased with debits
Schemes Exam UPDATED ACTUAL
QUESTIONS AND CORRECT ANSWERS
Statement of changes in owners' equity - CORRECT ANSWER details the changes in the total
owners' equity amount listed on the balance sheet
-it shows how the amounts on the income statement flow through to the balance sheet
--it acts as the connecting link between the two statements. The balance of the owners' equity at the
beginning of the year is the starting point for the statement. The transactions that affect owners' equity
are listed next and are added together. The result is added to (or subtracted from, if negative) the
beginning-of-the-year balance, which provides the end-of-the-year balance for total owners' equity.
Balance sheet or statement of financial position - CORRECT ANSWER a "snapshot" of a
company's financial situation at a specific point in time, generally the last day of the accounting
period
-an expansion of the accounting equation, Assets = Liabilities + Owners' Equity
Assets are the resources owned by a company.
-presented on the balance sheet in order of liquidity (i.e., how soon they are expected to be converted
to cash).
-in a financial statement fraud scheme, the balance sheet is manipulated to appear stronger by
overstating assets and/or understating liabilities.
-Current assets: cash or other liquid assets that are expected to be converted to cash, sold, or used up,
usually within a year or less.
--include: cash, accounts receivable, inventory, supplies, and prepaid expenses
-long-term assets: assets that will not be converted to cash in the near future, such as fixed assets and
intangible assets
-fixed assets: presented net of accumulated depreciation
--an amount that represents the cumulative expense taken for wear-and-tear on a company's property.
Liabilities are presented in order of maturity
-current liabilities: obligations that are expected to be paid within one year
--accounts payable (the amount owed to vendors by a company for purchases on credit)
,--accrued expenses (e.g., taxes payable or salaries payable)
--portion of long-term debts due within the next year
-long-term liabilities: not due for more than a year
--bonds, notes, and mortgages payable
Includes:
-Notes payable, current assets, retained earnings, and accumulated depreciation can all be found on
the balance sheet.
Matching principle - CORRECT ANSWER requires that expenses be recorded in the same
accounting period as the revenues they help generate.
-Estimates, accruals, and allocations are often needed to meet this requirement.
-When a sale is recorded, the appropriate charges for cost of goods sold, or other expenses directly
corresponding to the sale, should be recorded in the same accounting period.
Gross margin, or gross profit - CORRECT ANSWER Two basic types of accounts are reported
on the income statement—revenues and expenses.
Revenues represent amounts received from the sale of goods or services during the accounting period.
-Most companies present net sales as the first line item on the income statement
-net means that the amount is the company's total sales minus any sales refunds, returns, discounts, or
allowances.
Net Sales = Sales - sales refunds, returns, discounts, or allowances
From net sales, an expense titled cost of goods sold or cost of sales is deducted.
-this expense denotes the amount a company spent (in past, present, and/or future accounting periods)
to produce the goods or services that were sold during the current period.
The difference between net sales and cost of goods sold is called gross margin, or gross profit, which
represents the amount left over from sales to pay the company's operating expenses.
Gross Margin = Net Sales - Cost of Goods Sold
,Revenue recognition principle - CORRECT ANSWER revenue is recognized or recorded when
it becomes realized or realizable, and earned.
-revenue should not be recognized for work that is to be performed in subsequent accounting periods,
even though the work might currently be under contract.
-revenue should be recognized in the period in which the work is performed
Conservatism constraint - CORRECT ANSWER requires that when there is any doubt, one
should avoid overstating assets and income
Principle's intention is to provide a reasonable guideline in a questionable situation
-ex: the use of the lower of cost or market rule as it relates to inventory valuation
If a company's financial statements intentionally violate the principal, they could be fraudulent.
Accounting equation - CORRECT ANSWER Assets = Liabilities + Owners' Equity
-is the basis for all double-entry accounting
Asset (e.g., cash) is stolen, the equation can be balanced by:
- increasing another asset
-reducing a liability
-reducing an owners' equity account
-reducing revenues (and thus retained earnings)
- creating an expense (and thus reducing retained earnings)
Removes a liability, the equation can be balanced by:
- decreasing an asset
-increasing a different liability
-increasing an owners' equity account
-increasing revenues (and thus retained earnings)
-reducing an expense (and thus increasing retained earnings)
, End of fiscal Year closing - CORRECT ANSWER The accounts reflected on the income
statement are temporary; at the end of each fiscal year, they are reduced to a zero balance (closed),
with the resulting net income (or loss) added to (or subtracted from) retained earnings on the balance
sheet.
When to deviate from generally accepted accounting principles (GAAP) - CORRECT ANSWER
a matter of professional judgment; there is no clear-cut set of circumstances that justify such a
departure.
Departures from GAAP can be justified in the following circumstances:
• It is common practice in the entity's industry for a transaction to be reported a particular way.
• The substance of the transaction is better reflected (and, therefore, the financial statements are more
fairly presented) by not strictly following GAAP.
• If a transaction is considered immaterial (i.e., it would not affect a decision made by a prudent reader
of the financial statements), then it need not be reported.
• There is concern that assets or income would be overstated (the conservatism constraint requires that
when there is any doubt, one should avoid overstating assets and income).
• The results of departure appear reasonable under the circumstances, especially when strict adherence
to GAAP will produce unreasonable results and the departure is properly disclosed.
The fact that complying with GAAP would be more expensive or would make the financial statements
look weaker is not a reason
Double-entry accounting - CORRECT ANSWER Every transaction recorded in the accounting
records will have both a debit and a credit
-The debit side of an entry will always equal the credit side so that the accounting equation remains in
balance.
Entries to the left side of an account are referred to as debits, and entries to the right side of an
account are referred to as credits.
Asset and expense accounts are increased with debits and decreased with credit
Liabilities, owners' equity, and revenue accounts are increased with credits and decreased with debits
