C254 WGU Practice Review 2024 Latest Questions With Complete Solutions

C254 WGU Practice Review 2024 In the past (early 20th century time-frame), what was the general consensus of the principal purpose of audits (including among auditors)? To detect fraud To certify for the public that management is qualified to run the entity To evaluate that companies follow GAAP Investigative and analytical purposes - ANS To detect fraud Why has there been so much frustration between the general public and auditors regarding fraud detection? The auditors were not sufficiently trained in GAAP rules and regulations to identify fraud risks properly. The public felt searching for fraud was pointless and was costing their investments too much money; if fraudsters want to hide things, they will succeed. The auditors were taking short cuts and trying to make as large a profit as possible and therefore weren't performing as they should have. The public wants all cases of fraud detected, while auditors felt they only needed to be "reasonably certain" of its absence. - ANS The public wants all cases of fraud detected, while auditors felt they only needed to be "reasonably certain" of its absence. True or False Auditors can only say, with 100% certainty, that there is no fraud if they examine every transaction. Otherwise, there will always be some measure of doubt. - ANS True AICPA and the Cohen Commission (the commission on auditor's responsibility) fought over something specific concerning the fall of Equity Funding in the 1970's. This conflict highlighted a major communication issue between auditors and financial statement users during much of the 20th century. What was this conflict about? How much responsibility should the auditor take when endeavoring to detect (or fails to detect) fraud The severity of punishment top management of the company with fraud should be subjected to when they perpetrate fraud The auditors consistently weren't detecting fraud due to improper training The public felt that auditors needed to be more of a consultant than anything else, but the AICPA disagreed with this - ANS How much responsibility should the auditor take when endeavoring to detect (or fails to detect) fraud True or False In the beginning of the 20th century, everyone believed that the main purpose of audits was to detect fraud. However, at this time, Standards on Audit Procedures (SAP's) began to come forth, making it official that auditors really were responsible for fraud, and that fraud detection was a priority second to none. - ANS False SAP No. 1 actually began to define audits as more than just fraud detection. Since then, audits never had has their principal purpose fraud detectio What did Audit Standard No. 99 do that previous standards didn't? Created a special SEC task force to aggressively attach/investigate all "high risk" public companies It establishes black and white standards to evaluate whether the auditor did their job correctly, especially in their search for fraud. Requires all auditors to publish their work papers so financial statement users can evaluate for themselves if the auditors were thorough enough or not. Established the purpose of audits to be a more consultatory in nature than verifying GAAP rules and fraud detection - ANS It establishes black and white standards to evaluate whether the auditor did their job correctly, especially in their search for fraud. True or False Despite many attempts to close the "expectation gap" between auditors and the public, the AICPA wasn't successful until SAS No. 99. - ANS True True or False The idea "fraud" was not explicitly addressed until the 1990's. Fraud was addressed as "errors and irregularities." - ANS False True or False Audit standards involving auditors' responsibility in fraud detection has been to "reasonably assure" the lack of fraud in financial statements, but didn't clearly articulate the breadth and scope of their responsibility until SAS No. 99, thus causing the "expectation gap" between the public and CPA auditors. - ANS True The AICPA has had one major goal in issuing auditing standards about fraud, but never really met its goal until SAS No. 99. What was that goal? Eliminate the gap between financial statement users' expectations and auditors' assurances. Eliminate the need for auditors to detect fraud and focus on evaluating internal controls and verify that all GAAP rules and regulations have been followed. Establish a formula/solution identifying potential red flags so auditors, if doing their job properly, can't fail to detect fraud. Create consultatory standards for auditors to follow; an excellent consultant, when given the reins to improve the company, will undoubtedly uncover the well-hidden cases of fraud. - ANS Eliminate the gap between financial statement users' expectations and auditors' assurances. True or False One of the unique, yet key, provisions of SAS 99 establishes that auditors refrain from trying to think like a "fraudster," and think more analytically. - ANS False It requires audit teams to envision themselves as the fraudster; the more creative their brainstorming, the better. True or False Inquiring several simple questions of management in the beginning is now sufficient under SAS No. 99. - ANS False Fraud should be considered through the whole process, as should necessary questions and clarifications asked of management. When brainstorming possible fraud risks, it is important to avoid what kind of group dynamic? Non-hierarchal system where everyone's ideas count Thoughts of criminal-like behavior. Groupthink Free-flowing ideas - ANS Groupthink Which of the following now needs to be documented (but wasn't required in the past) in audit work papers, according to SAS No. 99? Testing of internal controls Testing of journal entries All questions and answers asked of and answered by management Brainstorming session of possible fraudulent areas. - ANS Brainstorming session of possible fraudulent areas. True or False SAS No. 99 classified that auditors ARE required to detect, at the very least, cases of forgery and collusion. - ANS False Forgery and collusion are actually some of the most difficult types of fraud to identify and prove. Auditors are not expected to find all types of fraud on every case. What is one key paradigm shift reiterated by SAS No. 99? Fraud detection is an ongoing process, not just a step in planning the audit. Instead of searching for fraud, auditors are now required to only look for obvious red flags; fraudsters have become too creative to make it cost effective to search for fraud. Fraud is no longer a priority; verifying that IFRS and GAAP have been merged properly is the number one concern Every client needs to be viewed as a devious fraudster, always attempting to deceive. - ANS Fraud detection is an ongoing process, not just a step in planning the audit. Which of the following were explicitly reiterated in SAS No. 99 from No. 82? Maintain professional skepticism Making extensive inquiries of management whenever necessary Fraud detection has become an ongoing process, not just a piece in the planning process All of the above - ANS All of the above True or false If fraud risk is higher, the auditor should never incorporate spontaneity or any form of unpredictability in the audit. - ANS False The controller of HealthSouth drew on his audit experience and knew the regular processes and procedures to know how to hide hundreds of thousands of fraudulent transactions that easily avoided auditor scrutiny. True or False Research shows that many fictitious entries occur through the override of management controls. SAS No. 99 now requires testing these types of entries for every public company that has them. - ANS True SOX (Sarbanes-Oxley Act) created a private-sector, non-profit organization to help auditors concerning their responsibilities to detect fraud. What is the name of this organization? PCAOB (Public Committee Accounting Oversight Board PBCPA (Public Board for Certified Public Accountants) SECTAF (Securities and Exchange Commission Task-Force Against Fraud) AICPA (American Institute of Certified Public Accountants) - ANS PCAOB (Public Committee Accounting Oversight Board According to the financial statement fraud detection framework, fraud is rarely detected by which of the following: -Breaking down and analyzing internal controls Learning management's motivations -Analyzing the financial statements -Understanding the inherent risks of a specific industry - ANS Analyzing the financial statements True or False: Fearful of offending company personnel and being intimidated by company management are two reasons that an auditor could fail to react properly to negative evidence. - ANS True True or False: An active board of directors and audit committee drastically decreases the opportunity for management to commit fraud. - ANS True Of all the four corners of the fraud exposure rectangle, auditors traditionally focused on which part (and thus failed to evaluate the other three corners)? -Financial Results and Operating Characteristics -Management and Directors -Relationships with the entities -Organization and Industry - ANS Financial Results and Operating Characteristics True or false: Financial statement fraud occurs over 85 percent of the time, from collusion occurring among middle managers, to low management, thus fooling auditors and top management. - ANS False Financial statement fraud is usually perpetrated by top management, and most often in behalf of the organization. True or False: The importance of examining directors and management is to determine their exposure to, and motivation for committing fraud is immaterial. - ANS FALSE - Management always as access to all three corner of the fraud triangle (attitude, opportunity, and incentive) The frauds at Computer Systems (CEO was Robert Reed Rogers) and Lincoln Savings and Loan (Charles Keating) had what auditor failures in common? -Were too incompetent to properly perform the audit -Failed to evaluate the company's relationships with other entities -Failed to sample properly -Did not look into management's background - ANS Did not look into management's background True or False: Looking at management's motivations for committing fraud is analyzing the incentive portion of the fraud triangle. - ANS True By reviewing how involved the boards of directors are in decision-making processes and having a capable, involved internal audit committee, which aspect of management is being evaluated? -Their motivations -Ability to influence decisions -Management Turnover -Their backgrounds - ANS Ability to influence decisions True or false: SAS 99 has the new requirement of auditors to ask management if they are committing, or are aware of, any instances of fraud. - ANS True A Variable Interest Entity (VIE) can be -Equity investments -Leases -Forward contracts -All of the above - ANS All of the above If, as an auditor, you discover a unique relationship between the client CEO and a bank president with whom the company has loans, and you investigate further, what part of the Fraud Exposure Rectangle are you investigating? -Financial Results and Operating Characteristics -Management and Directors -Relationships with other Entities -Organization and Industry - ANS Relationships with other Entities True or False: Recognizing intangible assets and intercompany transactions occurring at strategic times should be more closely examined by the auditor. - ANS True Why would the relationships between lawyers and firms be examined closely? -Lawyers are almost always hiding material misstatements -Lawyers are knowledgeable about the law and not how accounting procedures are done -Lawyers advocate for their clients and will support them until it is blatantly obvious fraud occurred -Lawyers pursue business simply for the money - ANS Lawyers advocate for their clients and will support them until it is blatantly obvious fraud occurred True or False: When a firm changes lawyers they are required to file an 8-K just like with a change of auditors. - ANS False Since they do not have the same disclosure requirements, that is why it is important to look more closely when a change of legal representation occurs. Having an unduly complex organizational structure should mostly be categorized as a symptom of Fraud Poor internal controls Incompetent internal controls None of the above - ANS Fraud True or False: Fraud is less likely to occur when there are family relations involved with management and other members of the company. - ANS False Families are usually complex, and complications Which of the following are areas of questions auditors should consider when analyzing management's exposure to potentially perpetrate fraud? Significant declines in customer demand and client sales High degree of competition and market saturation accompanied by declining margins High employee turnover All of the above - ANS All of the above According to Pincus, Asene, and Wright, checklists during audits constrain auditors from reasoning strategically. - ANS True In the topic, the framework for detecting financial statement fraud is critically important because: -Each type of fraud is unique (e.g., revenue recognition, asset overstatement) and thus each type of fraud requires a unique detection framework. -Many of the approaches used to detect fraud exposures are similar, regardless of organization or fraud scheme. -The role of the auditor and the tools and techniques auditors use vary according to fraud and this topic is important because it emphasizes those differences. -All of the Above. - ANS Many of the approaches used to detect fraud exposures are similar, regardless of organization or fraud scheme. Which of the following are the two most commonly manipulated to perpetrate financial statement fraud? -Revenues and Accounts Receivable -Inventory and Common Stock Holders' Equity -Revenues and Liabilities -Inventory and Accounts Receivable - ANS Revenues and Accounts Receivable SAS 99 requires auditors to assume there are material misstatements in revenue, though realizing there are situation-specific methods to recognize revenue and interpret the associated rules. - ANS True Barry Minkow (a convicted fraudster) said: "Receivables are a wonderful thing - you create a receivable and you have ________________." Expenses Cash Liabilities Revenue - ANS Revenue Stuffing distribution channels with promises to take back excess inventory free of charge directly violates GAAP revenue recognition rules. - ANS True Understating the Allowance for Doubtful Accounts allows fraudsters to -Overstate Receivables and Net Income -Recognize excess revenue -Understate total assets -Overstate payables - ANS Overstate Receivables and Net Income Auditors can usually quickly detect fraud because when it's committed, it's obvious. - ANS False Most of the time only symptoms, indicators and red flags are observable Symptoms involving activities, relationships, or unusual events (too big, too small, off-season, etc.) are part of which fraud symptom category? Analytical Symptoms Control symptoms Accounting or Documentary Symptoms Life style symptoms - ANS Analytical Symptoms Changes in behavior can be an excellent indicator of a first-time offender of fraud. - ANS True Which of the following are considered Control Fraud Symptoms? Management override of significant internal controls relating to the revenue cycle New, unusual, or large clients that appear to have bypassed usual customer-approval process All of the above None of the above - ANS All of the above Focusing on the changes in dollar amounts on the financial statements from period to period is the least effective method of comparisons. - ANS True Which of the following is the most efficient method to analyze recorded amounts from one period to another? Horizontal Analysis (compare percentages) Statement of Changes in Stockholders' Equity Compare dollar amount changes from period to period Examine changes from period to period in study of statement of cash flows - ANS Examine changes from period to period in study of statement of cash flows. The Gross Profit Margin will immediately point auditors to the source of fraud when it exists. - ANS False If there are fraud symptoms found in the GM ratio, it could a number of many things, from an overstatement of ending inventory to a decrease in discounts given, to an overstatement of revenues, to name a few. If the Gross Margin ratio increases dramatically, this should send what kind of a signal to auditors? Decrease company Excellent innovation Red Flag Superior marketing - ANS Red Flag If the number of days to collect is increasing, then it could be due to fictitious receivable not ever getting collected. - ANS True When doing common size financials, the 100% benchmark for the balance sheet should be An industry standard Competitor's total assets or total liabilities Total Sales Total assets or total liabilities & equity - ANS Total assets or total liabilities & equity Financial Statement fraud is usually to enrich the lives of management, not make the company more appealing to current and potential investors. - ANS False Most financial statement fraud is to make the firm look better to outside viewers Which of the following are legitimate fears of individuals aware of fraud (but not necessarily culpable)? They don't know who to tell or how to come forward They don't want to wrongly accuse someone They usually only have suspicions - no cold, hard facts All of the above - ANS All of the above According to SAS 99, not relying on a company's internal controls when evaluating a high fraud-risk area increases auditor's possibility of missing fraud. - ANS False By not relying on internal controls (pretending they don't exist), we dig further than we normally would and thus increase the possibility of detecting fraud _________________ means "reason to believe that fraud may be occurring. When __________________ exists and conditions warrant, an investigation should take place. Illegal Activity Fraud Dishonesty Predication - ANS Predication Revenue recognition is the most violated rule by fraudsters. - ANS True Focusing on the changes in dollar amounts on the financial statements from period to period is the least effective method of comparisons. - ANS True If _____________ is understated, then ________________ will directly be overstated (less tax effect). S & G Expenses, Cost of Goods Sold Net Income, Cost of Goods Sold Cost of Goods Sold, Net Income Sales Discounts, Total Expenses - ANS Cost of Goods Sold, Net Income Cost of goods sold can be understated by overstating ending inventory. - ANS True There are over 15 ways of manipulating cost of goods sold. To what end does a fraudster usually do this? Increase Sales Pay more in taxes for the current period Decrease operating income Increase net income - ANS Increase net income "Reported cost of goods sold balances that appear too low or are not increasing fast enough" is what type of symptom? Accounting and documentary Behavioral Analytical Control - ANS Analytical "Unusual or suspicious-looking purchase orders, invoices, shipping docs, and/or receiving docs" is what type of symptom? Behavioral Accounting and documentary Tips and complaints Analytical - ANS Accounting and documentary When offsetting /inflating ending inventory amounts to the fraud, the fraudster needs to continue inflating that amount from year to year to continue the farce. - ANS True Which of the following is a way to proactively search for inventory/cost of goods sold analytical symptoms? Focus on changes in recorded balances from period to period Focus on changes in relationships from period to period Comparing financial statement data with that of industry competitors All of the above - ANS All of the above Neither the inventory turnover ratio nor the days to sell inventory ratio help to discover potential red flags in inventory and cost of goods sold. - ANS False when used across time, they are extremely helpful in identifying potential fraudulent areas. When analyzing asset amounts to be reported on the balance sheet, an excellent method to verify them is to Add quarterly statements together to see if it equals ending inventory Inquiring of management if the reported amounts are representationally faithful Compare recorded amounts with what they actually represent (count physical assets) - ANS Compare recorded amounts with what they actually represent (count physical assets) Generating random numbers to select samples is not an ASB-certified auditing method. - ANS False It is an excellent way to introduce surprise into the audit and keep biases out of the audit. By increasing sample size, the auditor is decreasing the ________________ . Professional skepticism Chance to catch fraud Confidence there is no fraud Risking of missing fraud - ANS Risking of missing fraud In relation to organizational structure and procedures, it is the lack of good _______ ________ that provides the opportunity for fraud to occur. Inventory management Inventory storage Inventory controls Inventory trackers - ANS Inventory controls The best way to tell if management is lying is to identify inconsistencies between what the auditor observes (symptoms) and what management says. - ANS True Auditors should not establish good rapport with management because it could cause a conflict of interest if they become too close. - ANS False Research by Leinicke, Ostrosky, Rexroad, Baker, and Beckman in 2005 showed good rapport encourages open and two-way communication and allows for the auditor to identify specific behavior changes. Which is the best example of effective inquiry of management? Are you familiar and do you fully understand the inventory controls associated with your department? What internal control problems do you have in your department in relation to inventory? Are your inventory controls functioning properly? Do you regularly check and test your controls for deficiencies? - ANS What internal control problems do you have in your department in relation to inventory? A good ending question to an interview would be an open-ended, non-threatening and general question about potential issues of which they might be aware. - ANS True In searching for tips and complaints symptoms, an auditor should Test internal controls for errors or holes Review inventory tracking systems Evaluate the lifestyle of management Get in contact with vendors and suppliers about their relationships with the company. - ANS Get in contact with vendors and suppliers about their relationships with the company. After an auditor finds symptoms of fraud, the auditor should not alter the audit approach so as to make sure proper documentation is recorded. - ANS False Proper documentation techniques should already be a habit, regardless of the method of testing and investigating. Also, altering the audit approach adds the element of surprise required by SAS 99 Of all the types of fraud, inventory fraud is the most difficult to commit because the lie perpetuates from period to period (creating an offsetting error that must be maintained). - ANS True Neither the inventory turnover ratio nor the days to sell inventory ratio help to discover potential red flags in inventory and cost of goods sold. - ANS True Which of the following is a transaction that creates real liabilities for a company? Co-signing on a loan as a secondary signee. Collecting cash prior to the performance of a service. None of the above. - ANS Collecting cash prior to the performance of a service. Collecting cash prior to performing a service creates an unearned revenue liability. Note: Co-signing on a loan as a secondary signee would create a contingent liability - not a real liability (see topic 6 for more information). When accounts payable-related liabilities are understated, purchase and inventory are often ___________. Overstated Understated There is no effect on purchases and inventory - ANS Understated Understatement of liabilities usually means the offsetting entry to purchases or inventory also has been understated (see topic 6 for more information). Which of the following types of fraud symptoms usually provides the best opportunity to find contingent liabilities that should be recorded? Analytical Symptoms Documentary Symptoms Lifestyle Symptoms Tips and Complaints - ANS Documentary Symptoms Documentary symptoms provide the best opportunity to find contingent liabilities that should be recorded (See topic 6 for more information). Recognizing unearned revenue as earned revenue is an example of what type of fraud? Cost of goods sold fraud Overstatement of asset fraud Inadequate disclosure fraud Understatement of liability fraud - ANS Understatement of liability fraud Recognizing unearned revenue as earned revenue is an example of understatement of liability fraud. Note: Understating accounts payable would not affect cost of goods sold fraud, but could affect the gross margin ratio When examining whether a company has understated accounts payable, which of the following ratios will be most helpful? Accounts payable/cost of goods sold. Unearned revenue/accounts payable. Gross profit margin. Sales return percentage. - ANS Accounts payable/cost of goods sold. Accounts payable/cost of goods sold is helpful in determining whether a company is understating its accounts payable (See topic 6 for more information). Note: The gross profit margin is useful to detect inventory and cost of goods sold as well as revenue-related financial statement fraud. Similarly, the sales return percentage provides a measure of the percentage of sales that are being returned by customers and is useful in detecting revenue-related financial statement fraud. All of the following are common methods to commit understatement of liability fraud, except: Understate accrued liabilities. Recognizing unearned revenue as earned revenue. Understate accounts payable. Over-recording future obligations. - ANS Over-recording future obligations. In order to commit understatement of liability fraud, a perpetrator would need to under-record future obligations, not over-record them (see topic 6 for more information). Detection of financial statement fraud can be seen on a spectrum of difficulty, one extreme being "easy-to-detect" and the other extreme being "probably could-not-have-been-detected-by-any-auditor?" - ANS True Which of the following does not increase the difficulty of detecting fraud (from an auditor's point of view)? Collusion by fraudsters Forgery Fraud that is small (relative to financial statement balances and materiality) All of the above make detecting more difficult. - ANS All of the above make detecting more difficult. Collusion is the one thing that auditors can't test for (people can lie and be cohorts with another), auditors are not trained to identify forgeries, and small frauds can be mistaken with minor misstatements. From a financial statement user standpoint, which of the following statements best describes why liability fraud can be so detrimental? fraud always results in bankruptcy, reducing investor value to zero. Fraud revelations always decrease trust in outside auditors' competencies and thus reduces the trustworthiness of all audited financial statements Getting away with the fraud encourages management to commit ever-increasing frauds Risk is severely understated and skews decision-making - ANS Risk is severely understated and skews decision-making Liability fraud schemes are virtually the same, regardless of the firm and industry. - ANS False FALSE - Each industry has unique risks, unique financing opportunities and needs, and therefore has unique schemes. In evaluating "purchase inventory" transactions, which of the following fraud schemes is most applicable? Overstate purchase returns and purchase discounts Not recording warranty (service) liability Borrowing from related parties All of the above are fraud schemes involving the purchase of inventory - ANS Overstate purchase returns and purchase discounts Not recording warranty (service) liability: This scheme relates to the selling of finished products, not the purchasing of raw inventory. Borrowing from related parties: This scheme relates to borrowing money transactions. If a business, for example, requires tenants to make deposits that could mistakenly be recorded as revenue, which liability account should get examined further for potential fraud? Accounts payable Notes payable to tenants Contingent liabilities Unearned revenue - ANS Unearned revenue When Accounts Payable-related liabilities are understated, what other accounts are usually understated as well? Accounts Receivable and Cost of Goods Sold Purchases and Accounts Receivable Inventory and Cost of Goods Sold Purchases and Inventory - ANS Purchases and Inventory Understating unearned revenue has a two-fold positive benefit on the financial statement: increased revenues and decreased liabilities in the current period. - ANS TRUE - this is comparison between what the real journal entry should look like and what the fraudulent entry looks like: REAL Fraudulent Cash 500 Cash 500 Unearned Revenue 500 Revenue 300 Unearned Revenue 200 According to FASB ASC 450: Contingencies, when do contingent liabilities need to be recorded (versus simply disclosed or not even mentioned) on the financial statements? Firms must always record or disclose any contingent liability When the likelihood of loss or repayment is remote When the likelihood of loss or repayment is probable When the likelihood of loss or repayment reasonably probable - ANS When the likelihood of loss or repayment is probable If an auditor finds photo-copied purchase-related records where originals should exists, the auditor should take that as a potential fraud symptom and act accordingly. - ANS TRUE - This is an identified documentary symptom of fraud. Understated accrued liability documentary symptoms relate to specific accounts. Which of the following would best help and/or identify documentary symptom for the understatement of interest? Determining the Note Payable Balance is too low. Existence of Note Payables with no interest expense Having employees with no withholdings Identical amounts of interest expense deducted on the tax return and the financial statements - ANS Existence of Note Payables with no interest expense Determining the Note Payable Balance is too low: This is an analytical symptom Having employees with no withholdings: This references a different account. Each account could be subject to different fraud schemes, all of which could be separate and distinct from each other. Identical amounts of interest expense deducted on the tax return and the financial statements: Had this said "Interest deducted on tax returns but no on the financial statements" would have made this correct. Documentary symptoms provide the best opportunity to find contingent liabilities that should be recorded. - ANS TRUE - Finding communications between the client and lawyers, or payments to lawyers (without an acknowledged litigation), mention of litigation in minutes, etc., are all excellent ways to detect missing balances. An excellent way to actively search for analytical symptoms is to make comparisons. However, the comparisons should only be made within current year and previous year financial statements. - ANS FALSE - It is a good idea to compare internal trends with industry averages, trends of similar firms, or even company financial statement data with non-financial statement data. When looking for liability fraud, every individual account is a separate and distinct candidate for fraud (versus grouping similar accounts, or searching for fraud in one account and finding it in a related account). - ANS True ______________ in the acid test ratio (QA ÷ CL) and Current Ratio (CA ÷ CL) with ____________ in the ratios Accounts Payable/Cost of Goods Sold (AP ÷ COGS) and Accounts Payable/Inventory are most indicative of fraud. Decreases; Decreases Increases; Increases Increases; decreases Decreases; Increases - ANS Increases; decreases Many Financial statement ratios should be examined over time and observed and compared with auditor expectations. The auditor should attempt to explain why "significant deviations" occurred. - ANS True There are different things to consider when deciding on a ratio to use. A good question an auditor should always ask is Is management aware of the increases in X liability account over the last five years? What should this liability balance relate to, and how has that relationship changed over time. What has this balance been increasing (decreasing) over the last five years? Why is this liability never getting paid down? - ANS What should this liability balance relate to, and how has that relationship changed over time. With asset-based financial statement frauds, assets are most often: Neither understated nor overstated Understated Overstated - ANS Overstated Assets are most often overstated in asset fraud. This normally decreases expenses and improves how profit looks (See topic 7 for more information). Which of the following is a way to commit asset fraud? Overstating fixed assets Under-recording payroll taxes Over-recording contingent liabilities Recording sales discounts too high - ANS Overstating fixed assets Overstating fixed assets is a way to commit asset fraud (see topic 7 for more information). Note: Over-recording contingent liabilities would make the company appear less profitable than it actually is and recording sales discounts too high would also make the company appear less profitable than it actually is. The WorldCom fraud was primarily an example of which type of fraud? Inventory-related financial statement fraud Understatement of liability-related financial statement fraud Revenue-related financial statement fraud Overstatement of asset fraud - ANS Overstatement of asset fraud The WorldCom fraud was primarily an example of overstatement of asset fraud because this fraud involved capitalizing the amount that should have been expensed (See topic 7 for more information). Which of the following is not a common way in which companies overstate their assets during a merger or acquisition? Inappropriately use market values instead of book values. Improperly allocate book values to assets. Under-record various liabilities. - ANS Under-record various liabilities. While this is a common way to understate liabilities, and thus falsely improve the financial statements, it is not commonly used during mergers and acquisitions (See topic 7 for more information). Note: Inappropriately using market values instead of book values and improperly allocating book values to assets are both common ways in which companies overstate their assets during mergers and acquisitions. Which of the following ratios is not useful in detecting overstatement of asset fraud? Individual fixed asset account balances/Total fixed assets. Fixed asset/Total current liabilities. Total deferred charges/Total assets. Deferred charge write-offs (amortization)/Deferred charge balance. - ANS Fixed asset/Total current liabilities. Fixed asset/total current liabilities ratio would not be helpful in detecting fixed asset overstatement fraud. Note: Individual fixed asset account balances/total fixed asset ratios can be used to detect fixed asset overstatement fraud. Similarly, total deferred charges/Total assets is an effective tool to detect overstatement of asset fraud. Finally, deferred charge write-offs (amortization)/Deferred charge balance is an effective tool to detect overstatement of asset fraud (See topic 7 for more information). Which of the following is not a common way to overstate fixed assets (property, plant, and equipment)? Inflated amounts are recorded in non-arm's-length purchase transactions. Assets are not written down to their appropriate book, market, or residual values. Allowance for doubtful accounts is recorded too high. Assets that simply do not exist are fictitiously recorded in the financial statement accounts. - ANS Allowance for doubtful accounts is recorded too high. If the allowance for doubtful accounts is recorded too high, the company will appear less profitable than it actually is. As a result, this is not a common method used to manipulate the financial statements. With regard to deferred charges that are capitalized, the most important question to ask is: Whether the costs are being incurred to generate future revenues or whether there is likelihood that sufficient future revenue will be generated against these costs. The opinion of the chief executive officer concerning the value of such deferred costs. Whether the appraisal of the deferred cost justifies the amount capitalized. Current economic trends in company profitability. - ANS Whether the costs are being incurred to generate future revenues or whether there is likelihood that sufficient future revenue will be generated against these costs. True or False: With regard to appropriate company disclosure, a public company can never be charged with fraud because of an omission of material facts. - ANS False Which of the following provides the best statement regarding the means by which financial statement fraud gets started: Fraudsters carefully plan and execute their first fraudulent transactions to both project their fraudulent performance and conceal that effort from oversight mechanisms such as the audit. Fraudster carefully plan and execute their first fraudulent transactions to project their fraudulent performance but seldom are concerned with oversight mechanisms such as the audit. Financial reporting fraud is like starting down a slippery slope - once started, it is hard to stop, especially if the organization needs profits. Management fraud never involves cash assets. - ANS Financial reporting fraud is like starting down a slippery slope - once started, it is hard to stop, especially if the organization needs profits. A Ponzi scheme is best described as Bernie Madoff described his actions as that of a Ponzi investment because Charles Ponzi is believed to be the greatest investor of all times. Charles Ponzi was a fictitious character created for the movie Matchstick Men that depicted crafty investment schemes. A Ponzi scheme is a fraudulent investment operation where the operator, an individual or organization, pays returns to its old investors from capital provided by new investors, rather than from profit earned by the organization. Any fraud or corruption act because Charles Ponzi was the first fraudster ever documented by the Securities and Exchange Commission. - ANS A Ponzi scheme is a fraudulent investment operation where the operator, an individual or organization, pays returns to its old investors from capital provided by new investors, rather than from profit earned by the organization. Which of the following type of fraud scheme is typically hardest to detect: -Fraud schemes involving property, plant and equipment -Fraud schemes involving cash -Fraud schemes involving collusive behaviors with persons outside the company -Fraud schemes that involve a single, large transaction - ANS Fraud schemes involving collusive behaviors with persons outside the company Which of the following victims typically suffer the harshest outcomes associated with asset fraud: -Debtors. -Employees who participate in retirement plans that invest in mutual funds. -Stockholders. -The local charities who receive yearly contributions from the fraud victim. - ANS Stockholders. Cash is an easy asset to overstate because the bank will confirm the fraudulent balance to the auditors. - ANS False Which of the following statements is most accurate? Understated liability schemes are easier to identify than other types of financial statement fraud because the understated liabilities are always included in the numbers on the balance sheet. Revenue overstatement schemes are easier to identify than other types of financial statement fraud because the overstated revenues are always included in the numbers on the balance sheet. Asset overstatement schemes are easier to identify than other types of financial statement fraud because the overstated assets are always included in the numbers on the balance sheet. Retained earnings overstatement schemes are easier to identify than other types of financial statement fraud because the overstated retained earnings is always included in on the balance sheet. - ANS Asset overstatement schemes are easier to identify than other types of financial statement fraud because the overstated assets are always included in the numbers on the balance sheet. Auditors should always carefully look to make sure the underlying assumptions for capitalization makes sense and are reasonable. - ANS True Asset overstatement symptoms include all but which of the following: Last minute asset adjustments by the entity that significantly improve financial results. Missing documents related to assets. Availability of only photocopied documents to support asset transactions when documents in original form are supposed to exist. All of the above. - ANS All of the above. Which of the follow statements is most accurate? In most cases involving improper capitalization, weak controls around the capitalization process led to the wrong type of costs being capitalized. In most cases involving improper capitalization, weak controls around the capitalization process led to the wrong amount of costs being capitalized. In most cases involving improper capitalization, weak controls around the capitalization process led to not only the wrong type of costs being capitalized, but also the wrong amount of costs being capitalized. None of the Above - ANS In most cases involving improper capitalization, weak controls around the capitalization process led to not only the wrong type of costs being capitalized, but also the wrong amount of costs being capitalized. True or False Typically, analytical fraud symptoms are most helpful in determining asset overstatements related to mergers or restructuring because the auditor is comparing trends and changes. - ANS False Overstated fixed assets generally get on the financial statements in one of three ways. Which of the following is NOT one of those ways? Revenues are capitalized inappropriately in the balance sheet and not removed to the income statement in the proper period. Inflated amounts are recorded in non-arm's-length purchase transactions. Assets are not written down to their appropriate book, market, or residual values because insufficient depreciation is recorded, the assets are obsolete, or values of the assets are otherwise impaired. Assets that simply do not exist are fictitiously recorded in financial statement accounts. - ANS Revenues are capitalized inappropriately in the balance sheet and not removed to the income statement in the proper period. True or False Related parties are seldom involved in fixed assets being recorded at inflated amounts. - ANS False America's capital markets are the envy of the world because of their efficiency, liquidity, and resiliency. What role do financial statements play in American capital markets? Financial statements don't really play a role in American financial markets; they are too unreliable and fraud is a guarantee. They are designed to show the best side of company, and therefore are more used for marketing tactics They prevent monopolies by publicly disclosing trade secrets and competitive procedures. They present a fair picture of the financial position and results of the organization - ANS They present a fair picture of the financial position and results of the organization Why are American financial statements so widely trusted? They are prepared with integrity and there is a system that checks all published statements. The SEC provides an independent accountant on the board of directors of public companies to deter fraud. Public companies on the NYSE, NASDAQ, DOW JONES, etc., have learned that fraud doesn't pay, thus making fraud a practice of the past. America has some of the best computers in the world and can quickly and efficiently generate near flawless financial statements. - ANS They are prepared with integrity and there is a system that checks all published statements. True or False The SEC views auditors of public companies as "unreliable and frequently incompetent." - ANS False The SEC refers to auditors as the "public's watchdog" in the financial reporting process. True or False Financial statements don't need to be as accurate as possible. There is so much that goes into building them that there are bound to be mistakes. - ANS False Many decisions are based on the information provided in financial statements. When there are substantial errors, companies reissue their statements to provide information as accurate and fair as possible. In 2002, a landmark piece of legislation was signed into law to protect against and deter fraud, which also created a private sector organization called the PCAOB (Public Committee Accounting Oversight Board) to help. What was it? Sarbanes-Oxley Act (SOX) Foreign Corrupt Practices Act (FCPA) Anti-Insider Trading Act (AITA) SEC Fraud Act of 2002 (FRACT) - ANS Sarbanes-Oxley Act (SOX) What is the most significant "red-flag" or tell-tale sign of fraud? The symptoms, or red-flags, cannot be ranked in order of their significance or extent. Huge fluctuations in balance sheet amounts from year to year. Unhelpful and argumentative managers, controllers, etc. Excessive amounts of management override controls for journal entries. - ANS The symptoms, or red-flags, cannot be ranked in order of their significance or extent. Motivations for fraud change from case to case, though there tends to be a common theme. Which of the following is that "common theme?" -Attempt to improve financial information to support high stock price -To support a bond or stock offering -To increase stock price -All of the above - ANS All of the above True or False: Financial statement fraud affects everyone, not just those directly or indirectly involved with the fraudulent company. - ANS True True or False By its nature, fraud is a hidden and secret act. Therefore, it is difficult to detect and even harder to prove. - ANS True True or False Only large, multi-million dollar companies perpetrate fraud; large risk equals large reward. - ANS False Any size company can commit fraud, from Fortune 100 to Fortune 500. Size is irrelevant when looking for fraud. In most cases of fraud, who was implicated in those cases as, at the very least, being complicit? CEO and CFO (89%) Controller and CFO CAO (Chief accounting officer) and CFO Controller and a select group of middle managers. - ANS CEO and CFO (89%) What is the most common technique used to manipulate financial statements? Hiding expenses and debt off book in SPEs Intercompany transactions Overstating inventory Misstatement of revenues - ANS Misstatement of revenues While not the most common tactic(s) of perpetrating fraud, which of the following are still considered "very common?" Improper capitalization of assets Use of off balance sheet SPE's to hide debt and expenses Overstatement of existing assets All of the above - ANS All of the above Within the misstatement of revenues concept, there are two schemes that are used most often. Which are they? Including intercompany transactions as revenue and creating fictitious revenues. Incorrectly consolidating subsidiaries (to show greater revenue) and misclassification of lease revenue Overcharging clients and classifying thefts as revenue Improper timing of revenues and fictitious revenues. - ANS Improper timing of revenues and fictitious revenues. Though the percentage of financial statement frauds is relatively small, the damage they can cause can be enormous. - ANS True Why is it important to be extra cautious when changing auditors? On average, one out of four companies with fraud switched auditors during the fraud period or right before the fraud period. Companies only switch auditors to take advantage of the new auditor, who will want to please and will be more "understandable" when they find fraud. The new auditor will have none of the old work papers from previous audits and won't know what's "normal" for the client It is highly likely that the previous auditor was involved in the fraud scheme and wanted to leave to avoid implication - ANS On average, one out of four companies with fraud switched auditors during the fraud period or right before the fraud period. Many fraud cases begin their frauds with schemes too large to catch with just one audit, like in the case of Phar-Mor. - ANS False Phar-Mor began its fraud with very simple and almost inconsequential misstatements, but escalated from there, like Health South as well. The reordering of expenses to more closely match projections and budgets is an acceptable practice when its net effect on the bottom line is unchanged. - ANS False Any manipulation of financial statements that is not a true and accurate representation of results is always fraud. Rarely do top executives have anything to gain in committing fraud - the common motivations are to avoid layoffs, minimize reductions in operations, and save the company. - ANS False Many top executives that committed fraud had considerable stock options, and the directly benefitted from an inflated stock price. Backdating stock options for top executives is a practice generally ignored and considered inconsequential because its impact on financial statements is immaterial. - ANS False Backdating is a type of fraud entirely motivated by greed that violates SEC reporting rules, GAAP regulations, and other standards. Which of the following types of frauds are considered the most difficult to find, usually requiring a tip? Overstatement of asset-related financial statement fraud. Inadequate disclosure financial statement fraud. Revenue-related financial statement fraud. Cost of goods sold-related financial statement fraud. - ANS Inadequate disclosure financial statement fraud. Disclosure fraud is considered the most difficult type of fraud to find, usually requiring a tip (See topic 8 for more information). Inadequate disclosure fraud usually involves: Presenting individual categories of fixed assets in the financial statements rather than in separate footnotes. Omitting disclosures that should have been made in the footnotes. An increase in shipping costs at or near the end of the period. An increase in sales returns and sales discounts at the end of the period. - ANS Omitting disclosures that should have been made in the footnotes. Generally accepted accounting principles require that adequate disclosure be made in order to understand the financial statements (See topic 8 for more information). Which of the following statements about detecting inadequate disclosure fraud is true? Missing disclosures are harder to detect than misleading disclosures. The symptoms for detecting disclosure fraud are the same as for all other types of fraud. Organizations that are involved in inadequate disclosure fraud often reveal too much transparency in their footnote disclosures. All of the above - ANS Missing disclosures are harder to detect than misleading disclosures. Misleading disclosures can be observed; missing disclosures cannot. Which of the following is not one of the three categories of disclosure fraud discussed in the chapter? Overall misrepresentations about the nature of the company or its products. Misrepresentation in management discussions and other non financial statement sections of annual reports Misrepresentations in the footnotes to the financial statements. Explicit and implicit misrepresentations to SEC investigators. - ANS Explicit and implicit misrepresentations to SEC investigators. Disclosure fraud can be categorized into three different groups, including: 1). Overall misrepresentations about the nature of the company or its products, 2). Misrepresentation in management discussion and other non financial statements, and 3). Misrepresentations in the footnotes to the financial statements. Explicit and implicit misrepresentations to SEC investigators is not included in any of the three categories. The ratio "income from operations less cash flow from operations divided by income from operations" should generally be: Slightly positive Neither positive nor negative Slightly negative - ANS Slightly negative This ratio should be slightly negative because depreciation is subtracted from "income from operations" but not from "cash flow from operations." For more information, see topic 8. Which of the following is not a common method used to perpetrate disclosure fraud? Incorrectly disclosing contingent gains that are probably not going to occur. Failing to disclose contractual obligations Failing to disclose contingent liabilities that are reasonably probable. Delaying recognition of expenses through depreciation. - ANS Delaying recognition of expenses through depreciation. The only possible answer that is not a common method used to perpetrate disclosure fraud is delaying recognition of expenses through depreciation - which is commonly done to overstate assets (not disclosure fraud). For more information, see topic 8. Disclosing misleading information is not considered financial statement fraud if it is contained in the Management's Discussion and Analysis (MD&A) section of a Company's annual report. - ANS False False. Disclosures in the MD&A section of an annual report are considered part of the financial statements and can constitute financial statement fraud if they are misleading. Studies that look at the frequency of various types of financial statement fraud generally put inappropriate disclosure fraud as one of the top four most common forms of fraud with over 20% of all financial statement fraud cases involving this method. - ANS False False. Inappropriate disclosure frauds are generally reported in the studies to be a small percentage of the types of financial statement fraud (e.g., 1 percent). The COSO definition of inappropriate disclosure fraud is fraud that involves the issuance of fraudulent or misleading statements or press releases regarding financial statement line item effects. - ANS False False. COSO defined inappropriate disclosure fraud as fraud that involves the issuance of fraudulent or misleading statements or press releases without financial statement line item effects. Which of the following types of symptoms is most likely to reveal a disclosure fraud? Lifestyle symptoms Analytical symptoms Documentary symptoms Tips and Complaints symptoms - ANS Tips and Complaints symptoms Tips and Complaints symptoms are the only symptoms in this list that will likely reveal a disclosure fraud. Documents may sometimes be present but analytical symptoms won't usually exist because the disclosure fraud does not involve financial statement line items and lifestyle symptoms are unlikely to reveal any financial statement frauds. One of the major purposes of the Statement of Cash Flows is to show, on an accrual basis, the Company's sources and uses of cash. - ANS False False. The statement of cash flows shows a Company's sources and uses of cash but not on an accrual basis. Auditors are responsible for providing reasonable assurance that all material related party transactions have been properly disclosed. - ANS True True. GAAP and GAAS require auditors to provide this assurance. The Bre-X disclosure fraud involved promises that are conceptually similar to the promises made in investment scams and Ponzi schemes. - ANS True True. Topic 8.4 briefly mentions the similarities between these two types of frauds. Which of the following would not typically be used as potential sources of information regarding inadequate disclosures? Confirmations from tax authorities (e.g., the IRS) Invoices from attorneys Board of Director minutes Loan agreements - ANS Confirmations from tax authorities (e.g., the IRS) Confirmations from tax authorities was not mentioned and is unlikely to be something an auditor would obtain. Which of the following types of fraud is likely the most common type of footnote disclosure fraud? Failure to disclose material related party transactions Failure to disclose contingent liabilities Failure to disclose all related parties Failure to disclose important aspects of a Company's operations - ANS Failure to disclose material related party transactions GAAP does not require disclosure of all related parties only the material transactions that occurred with related parties. Which of the following parts of the annual report is characterized as part of the public relations efforts of a company? The management's disclosure area of the report Management's discussion and analysis section of the report The strategic performance section of the report None of the above - ANS Management's discussion and analysis section of the report. The management's discussion and analysis section of the annual report is where management communicates information that can be characterized as part of a Company's public relations efforts. The other options are not valid sections of an annual report. A Company will not usually be found guilty of fraud for misleading statements about the Company if the statements were made by a news outlet but are based on information obtained from the Company. - ANS False False. The Medical Fraud examples mentioned are cases where this form of disclosure fraud existed. Statements made by officials at the SEC show that the SEC is focused mostly on fraud found in the financial statements line items and not as concerned with statements made elsewhere in the annual report such as the management's discussion and analysis section. - ANS False False. Section 8.2 gives some statements by SEC officials that emphasize both the financial statements and the story provided by management in the MD&A section are the focus of the SEC. Which of the following is an example of a question that auditors should ask when looking for disclosure fraud related to the nature of a Company or its products? Does the company's success depend on complicated marketing schemes? Is the company making guaranteed promises? Does the company's success depend on someone's "unique expertise?" All of the above - ANS All of the above All of the above are questions mentioned in Topic 8.4. In the case of Bre-X Minerals, the fraud involved claims that the company discovered a new combination of minerals that could cure numerous health problems. - ANS False False. As mentioned in topic 8.2, Bre-X Minerals falsely claimed to have found and owned property with large deposits of gold. People will often be dishonest if they are placed in: An environment with poor controls. An organizational setting with strict accountability Positive modeling and labeling. A positive work environment. - ANS An environment with poor controls. Unfortunately, poor controls often lead to dishonest acts. Note: People are less likely to be dishonest if they work in a positive work environment. See topic 9 for more information. Which of the following is not a factor in creating a corporate culture of honesty and openness. Appropriate modeling by top executives Communicating expectations throughout the organization. Requiring periodic written confirmation of acceptance of ethical behavior. Recognizing that fraud can exist in any organization. Creating a positive work environment. - ANS Recognizing that fraud can exist in any organization. While 'recognizing that fraud can exist in any organization' is a key to preventing fraud, it is not a element of creating a culture of honesty and openness. See topic 9 for more information. Control activities include all of the following, except: Adequate segregation of duties Proper procedures for authorization Adequate documents and records All of the above - ANS All of the above Adequate segregation of duties, proper procedures for authorization, and adequate documents and records are all considered to be control activities. For more information, see topic 9. Which of the following factors generally results in a high-fraud environment? Hiring honest people. Autocratic management. Creating widespread monitoring by employees. Implementing a proper control structure. - ANS Autocratic management. Research indicates that having an autocratic management style will often lead to a high-fraud environment. See topic 9 for more information. Which of the following aspects of fraud usually results in the largest savings? Fraud prevention Fraud detection Fraud investigation Fraud resolution - ANS Fraud prevention Active fraud prevention policies result in big savings and helps ensure that fraud will be prevented or detected an at early stage. See topic 9 for more information. hich of the following is usually the most effective tool in preventing and detecting fraud? Having a good system of internal controls. Creating an expectation of punishment in the company. Requiring written confirmation of acceptance of expectations. - ANS Having a good system of internal controls. Having a good system of internal controls is usually the most effective tool against fraud. Proper modeling by which of the following individuals would be most important in an organization? A member of the board of directors A delivery driver The mailroom clerk The company CEO - ANS The company CEO The CEO. The reason is because the CEO sets the example and model for all employees and his/her actions are observed by all members of the organization. While the board member must model appropriate behavior, employees would not interact with board members. The sphere of influence of the delivery driver and mailroom clerk are not nearly as large as that of the CEO. Having a strong code of conduct would reduce most which element of the fraud triangle? Perceived opportunities Conversion Rationalization Perceived pressures - ANS Rationalization A clearly specified code inhibits rationalizations such as "It's really not that serious," "You would understand if you knew how badly I need it," "Everyone is a little dishonest,