Chapter 11 – Accounting Principles and FraudSolutions

1. According to COSO’s study, Fraudulent Financial Reporting: 1998-2007, which of

the following is the most likely to commit financial statement fraud?
a. Organized criminals
b. Mid-level employees
c. The chief exective officer and/or chief financial officer
d. Lower-level employees

2. Which of the following is a reason that a chief executive officer might commit
financial statement fraud?
a. To receive or increase a performance bonus
b. To avoid termination due to poor performance
c. To conceal the company’s true performance
d. All of the above

3. Senior management is most likely to understate business performance in the financial

statements for which of the following reasons?
a. To reduce the value of an owner-managed business for purposes of a divorce
settlement
b. To comply with loan covenants
c. To increase the value of a corporate unit whose management is planning a buyout
d. To trigger performance-related compensation or earn-out payments

4. Which of the following is not a reason that senior management would overstate
business performance to meet certain objectives?
a. To meet a lender’s criteria for granting/extending loan facilities
b. To meet or exceed the earnings or revenue growth expectations of stock market
analysts
c. To reduce current expectations so that future growth will be better perceived
and rewarded
d. To increase the amount of financing available from asset-based loans

5. If a fraudster manipulates the assumptions used to calculate depreciation charges in

order to increase earnings to a desired figure, which general method of financial
statement fraud is the fraudster using?
a. Going outside the accounting system
b. Beating the accounting system
c. Going around the accounting system
d. Playing the accounting system

6. When a fraudster feeds fictitious information into the accounting system in order to
manipulate reported results, this is called:
a. Going outside the accounting system
b. Beating the accounting system
c. Going around the accounting system
d. Playing the accounting system
7. If a fraudster uses his computer to produce fictitious financial statements while
completely ignoring the data in the accounting system, this is an example of what
general financial statement fraud method?
a. Beating the accounting system
b. Playing the accounting system
c. Going outside the accounting system
d. None of the above

8. The conceptual framework for financial reporting includes several assumptions that
underlie generally accepted accounting principles. Which of the following is one of
these assumptions?
a. Economic entity
b. Relevance
c. Matching
d. Comparability

9. Fraudulent manipulation of the going concern assumption usually results from an

organization trying to conceal its terminal business situation.
a. True
b. False

10. Intentionally reporting product sales in the financial statements for the period prior to
when they actually occurred is a violation of which generally accepted accounting
principle?
a. Periodicity
b. Matching
c. Historical cost
d. Revenue recognition

11. The financial statements for DRG Industries contain a misstatement that is so
significant that reasonable investors would likely make a different investment
decision if they were given the correct information. What concept of GAAP applies to
this situation?
a. Full disclosure
b. Revenue recognition
c. Materiality
d. Cost-benefit

12. Walden Industries is being sued by a former employee for wrongful termination. It is
probable that the company will lose the case and be ordered to pay the plaintiff a
significant sum of money. If Walden fails to report this information somewhere in its
financial statements, it is violating the GAAP concept of:
a. Materiality
b. Full disclosure
c. Matching
d. Cost-benefit
13. The conservatism constraint for financial reporting states that, if there is any doubt,
companies should aim to avoid overstating assets and income.
a. True
b. False

14. A company’s financial statements are the responsibility of:

a. The independent auditors
b. The shareholders
c. The accounting department
d. Management

15. The term “financial statement” does not include a statement of cash receipts and
disbursements, because this type of presentation violates the required use of accrual
accounting under GAAP.
a. True
b. False

16. Which of the following is not one of the provisions established under the Sarbanes-
Oxley Act?
a. Code of ethics for senior financial officers
b. Management assessments of internal controls
c. The creation of the Public Accounting Standards Board
d. Criminal penalties for altering documents

17. As the result of the Sarbanes-Oxley Act, the Securities Exchange Commission has
implemented which of the following rules?
a. New standards of professional conduct for attorneys
b. Insider trades during pension fund blackout periods
c. Conditions for use of non-GAAP financial measures
d. All of the above

18. Which of the following is a duty of the Public Company Accounting Oversight
Board?
a. Registering accounting firms that audit publicly traded companies
b. Establishing or adopting standards relating to audits of publicly traded companies
c. Enforcing compliance with professional standards and securities laws relating to
public company audits
d. All of the above

19. Investigating registered public accounting firms and their employees, conducting
disciplinary hearings, and imposing sanctions where justified are duties of which of
the following bodies?
a. General Accounting Office’s Oversight Board
b. Public Company Accounting Oversight Board
c. AICPA’s Accounting Standards Board
d. SEC’s Subcommittee on Corporate Governance
20. Under Sarbanes-Oxley, chief executive officers and chief financial officers are
required to personally certify annual and quarterly SEC filings. Which of the
following is an item that they must certify in their reports?
a. They have disclosed to the audit committee any material control weakness.
b. The financial statements were prepared in conformity with GAAP.
c. The company’s internal controls have prevented or detected all material instances
of fraud during the last year.
d. All of the above

21. The Sarbanes-Oxley Act provides that members of the audit committee may receive
compensation for consulting or advisory work only if approved by a majority of the
board members.
a. True
b. False

22. The Sarbanes-Oxley Act placed restrictions on the types of services that public
accounting firms are allowed to perform for audit clients. Which of the following
services are public audit firms now expressly prohibited from performing for their
audit clients?
a. Quarterly review services
b. Tax services
c. Bookkeeping services
d. All of the above

23. Under Sarbanes-Oxley, pubic accounting firms must rotate the lead partner or the
partner reviewing the audit every year.
a. True
b. False

24. The civil and criminal protections for whistleblowers under Sarbanes-Oxley apply
only to employees of publicly traded companies.
a. True
b. False

25. Vanessa Armstrong was the chief financial officer for D&G Technologies, a publicly
traded corporation. During the 20X1 fiscal year, she caused the company’s financial
statements to violate reporting requirements by including a significant overstatement
of revenue so that she would receive a large performance bonus. When her
transgression came to light, the company was required to issue restated financial
statements for 20X1. Under the provisions of Sarbanes-Oxley, Vanessa must
reimburse the company for any bonus she received during the 12 months after the
20X1 financials were initially filed.
a. True
b. False

26. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, the
most common type of occupational fraud is financial statement fraud.
a. True
 b. False

27. According to the 2012 Report to the Nations on Occupational Fraud and Abuse,
losses due to financial statement frauds are higher than other occupational fraud
schemes.
a. True
b. False

1. Which of the following is not an example of financial statement fraud?

a. Falsification of material financial records, supporting documents, or business
transactions
b. Unintentional misapplication of accounting principles
c. Deliberate omission of material disclosures
d. All of the above are examples of financial statement fraud

2. Staff Accounting Bulletin Topic 13, “Revenue Recognition,” indicates that revenue is
considered realized or realizable and earned when four criteria are met. Which of the
following is one of these criteria?
a. Collectibility is reasonably assured.
b. Goods have been scheduled to be delivered or services have been scheduled to be
rendered within the current fiscal period.
c. The seller has located alternate buyers.
d. All of the above are criteria for revenue recognition.

3. Recording revenue from a sale even though the rights and risks of ownership have not
yet passed to the purchaser is an example of what type of fictitious revenue scheme?
a. Partial sale
b. Circumstantial sale
c. Tentative sale
d. Sale with conditions

4. Which of the following is a red flag associated with fictitious revenues?

a. An unusual decrease in gross margin
b. An unusual decline in the number of days’ purchases in accounts payable
c. Several unusual and highly complex sales transactions recorded close to the
period end
d. Recurring losses while reporting increasing cash flows from operations

5. While conducting the annual audit of Bluebird Company’s financial statements, Elsie
Finnegan, CFE, CPA, came across some fishy findings. The company recorded
several large and unusual sales at the end of the fiscal year to customers Elsie had
never heard of. Further, all of these sales occurred within the company’s specialty
division, which had previously been in danger of closing due to recurring losses.
Based on these findings, what type of financial statement fraud is likely occurring?
a. Expense omission
b. Unrecorded warranties
c. Fictitious revenues
 d. All of the above

6. An unusual growth in the number of days’ sales in receivables can be a red flag for
which of the following financial statement fraud schemes?
a. Timing differences
b. Fictitious revenues
c. Improper asset valuation
d. All of the above

7. Sharpe Medical Supply, Inc. has suffered a recent slow-down in sales and is in danger
of showing a loss for the 20X1 fiscal year. To boost income, the sales manager
encourages two of the company’s largest customers to overbuy several slow-moving
products at deep discounts. He also offers them extended payment terms, some of
which delay payment until the end of 20X2. This is an example of what type of
scheme?
a. Channel stuffing
b. Discount extension
c. Sales re-routing
d. Long-term contracts

8. The preferred and easiest method of concealing liabilities and expenses is to simply
fail to record them.
a. True
b. False

9. An organization that seeks to fraudulently minimize its net income due to tax
considerations may do so by:
a. Recording fictitious revenues
b. Omitting existing liabilities
c. Expensing capitalized expenditures
d. Underestimating warranty repairs expense

10. It is more difficult to manipulate construction contracts that use the percentage of
completion method than contracts that use the completed contract method.
a. True
b. False

11. Capitalizing revenue-based expenses as depreciable assets will cause income to be

____________ in the current period and _______________ in future periods.
a. Understated; overstated
b. Understated; understated
c. Overstated; understated
d. Overstated; overstated

12. Which of the following is a red flag associated with concealed liabilities and
expenses?
a. Gross margin significantly lower than industry average
 b. An unusual increase in the number of days’ purchases in accounts payable
c. An unusual change in the relationship between fixed assets and depreciation
d. Significant reductions in accounts payable while competitors are stretching
out payments to vendors

13. An inability to generate cash flows from operations while reporting earnings and
earnings growth is a red flag for which of the following financial statement fraud
schemes?
a. Improper asset valuation
b. Fictitious revenues
c. Concealed liabilities and expenses
d. All of the above

14. GAAP strictly prohibits companies from engaging in all related-party transactions
because, without an arm’s-length business negotiation process, the company may
suffer economic harm and ultimately injure unsuspecting shareholders.
a. True
b. False

15. Management has an obligation to disclose to the shareholders any fraud that is
committed by the company’s employees or vendors.
a. True
b. False

16. At the suggestion of the external auditors, the audit committee of Alpha Technologies
called in Bryce Miller, CFE, to investigate some suspected improprieties. During his
investigation, Bryce learns that the company has been involved in several highly-
complex transactions with related parties that do not appear to have any logical
business purpose. Further, Alpha’s organizational structure is overly complex and
involves some unusual legal entities with overlapping lines of authority. Bryce also
discovers four large bank accounts in the Cayman Islands that have no clear business
justification. When questioned about these situations, the company’s CEO treats them
as unimportant and refuses to provide any further explanation. What type of financial
statement fraud scheme do Bryce’s findings most likely indicate?
a. Fictitious revenues
b. Improper asset valuation
c. Improper disclosures
d. Concealed expenses

17. Recurring attempts by management to justify marginal or inappropriate accounting

treatments on the basis of materiality is a red flag associated with which type of
financial statement fraud?
a. Improper disclosures
b. Fictitious revenues
c. Concealed liabilities
d. None of the above

18. Which of the following is a common target for improper asset valuation schemes?
 a. Accounts receivable
b. Business combinations
c. Inventory valuation
d. All of the above

19. An unusual change in the relationship between fixed assets and depreciation is a red
flag associated with which type of financial statement fraud scheme?
a. Timing differences
b. Improper asset valuation
c. Improper disclosure
d. All of the above

20. Which of the following is an example of improper asset valuation?

a. Fictitious accounts receivable
b. Understating assets
c. Misclassifying assets
d. All of the above

21. According to SAS 99 (AU 240), “Consideration of Fraud in a Financial Statement

Audit,” the auditor should ask management about the risks of fraud and how they are
addressed. Which of the following is not described as an issue that the auditor should
ask management about?
a. Whether management has knowledge of fraud or suspected fraud
b. Management’s understanding of the risk of fraud
c. Whether and how management communicates the company’s financial
results to its employees
d. Programs that the entity has established to prevent, deter, or detect fraud

22. According to AU 240, fraud involving senior management should be reported directly
to the shareholders as soon as the fraud is documented.
a. True
b. False

23. AU 240 requires auditors to document:

a. Any specific risks of material misstatement due to fraud that were identified
b. The discussion among engagement personnel regarding the susceptibility of the
entity’s financial statements to material misstatement due to fraud
c. The reasons supporting the auditor’s conclusion if the auditor has not identified
improper revenue recognition as a risk
d. All of the above

24. Vertical analysis is also known as “common sizing” of financial statements.

a. True
b. False

25. In the vertical analysis of an income statement, _____________ is assigned 100

percent, with all other items expressed as a percentage thereof.
a. Gross sales
 b. Net sales
c. Net income
d. Gross margin

26. The technique for analyzing the percentage change in individual financial statement
items from one accounting period to the next is known as:
a. Ratio analysis
b. Vertical analysis
c. Horizontal analysis
d. Correlation analysis

27. The textbook lists several ways to reduce the pressures to commit financial statement
fraud, including:
a. Avoiding setting unachievable financial goals
b. Maintaining accurate and complete internal accounting records
c. Having confidential reporting mechanisms to communicate inappropriate
behavior
d. Maintaining accurate personnel records including background checks on new
employees

28. Establishing clear and uniform accounting procedures with no exception clauses can
help reduce financial statement fraud by addressing which side of the fraud triangle?
a. Pressures to commit fraud
b. Opportunity to commit fraud
c. Rationalizations of financial statement fraud
d. Non-sharable problems

29. Promoting strong values, based on integrity, throughout the organization can help
reduce financial statement fraud by addressing which side of the fraud triangle?
a. Non-sharable financial needs
b. Opportunity to commit fraud
c. Pressure to commit fraud
d. Rationalization of fraud

30. Bill Raymond is the CEO of the Drummond Group, a consulting group in the
Carolinas. Sales have increased at least five percent every year for the past seven
years. Unfortunately, the company has hit a slump this year, and revenue is far less
than anticipated. However, in order to receive his performance bonus, Bill must show
a sales increase of at least seven percent. When the financials are released, sales have
increased by exactly seven percent. Which of the following ratio analyses would be
most helpful in revealing that Bill included bogus sales in the company’s financials?
a. Inventory turnover
b. Receivable turnover
c. Debt-to-equity ratio
d. Quick ratio

31. Sally Lauren is the external auditor for Modus Industries, a public company that
manufactures disk drives. As she analyzes the numbers, she finds that the quick ratio,
 which has typically remained consistent, increased from 1.7 to 2.3 over the previous
year. What type of financial statement fraud scheme could be occurring?
a. Inflated inventory
b. Omitted expenses
c. Fictitious accounts receivable
d. None of the above

32. Scott Ruskin is the CEO of Decatur Materials. The company has been struggling for
the last few years and is in danger of defaulting on several of its bank loan covenants.
Scott is facing significant pressure from the board of directors to turn the company
around. Unless he meets all of the financial goals for the year, he will be out the door
without a golden parachute. To improve the financial appearance of the company,
Scott undertakes a scheme to boost the balance sheet by faking inventory. The
analysis of what financial ratio would most likely bring this scheme to light?
a. Quick ratio
b. Collection ratio
c. Inventory turnover
d. Profit margin

33. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie
electronic stores in the New Jersey area, took fraud to a higher level. The company
started out as a small, family-owned business, but Eddie soon found that he could
really clean up by taking his company public and making a fortune off the sale of
stock. However, in order to sustain his financial success, he turned to cooking the
books. Unfortunately for Eddie, his scheme eventually came to an end. What
financial statement fraud scheme did Eddie commit?
a. Overstatement of inventory
b. Improper disclosures
c. Fictitious revenues
d. All of the above

34. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie
electronic stores in the New Jersey area, took fraud to a higher level. The company
started out as a small, family-owned business, but Eddie soon found that he could
really clean up by taking his company public and making a fortune off the sale of
stock. However, in order to sustain his financial success, he turned to cooking the
books. Unfortunately for Eddie, his scheme eventually came to an end. How was the
fraud caught?
a. His ex-wife contacted the SEC.
b. Eddie lost a proxy battle for ownership, and the company’s new owners
quickly discovered the fraud as they reviewed the books.
c. The audit committee received an anonymous tip which led them to the fraud.
d. The auditors found that the inventory count had been changed.

35. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie
electronic stores in the New Jersey area, took fraud to a higher level. The company
started out as a small, family-owned business, but Eddie soon found that he could
really clean up by taking his company public and making a fortune off the sale of
 stock. However, in order to sustain his financial success, he turned to cooking the
books. Unfortunately for Eddie, his scheme eventually came to an end. What
happened to Eddie Antar?
a. He fled the country and is still at large.
b. He repaid the money and was placed on probation.
c. He was convicted of racketeering and sentenced to prison.
d. He became a witness for the SEC against his cousin, the CFO, in exchange for a
reduced sentence.

36. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales,
Inc., a company that coated fabrics for use in producing things like parachutes, helmet
liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales
moved to the top of its industry, but ultimately the good times turned into bad times,
and the company declared bankruptcy. What type of financial statement fraud was
committed?
a. Fictitious assets
b. Fictitious sales
c. Improper disclosures
d. Concealed expenses

37. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales,
Inc., a company that coated fabrics for use in producing things like parachutes, helmet
liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales
moved to the top of its industry, but ultimately the good times turned into bad times,
and the company declared bankruptcy. Which of the following was a red flag that a
fraud was being perpetrated?
a. A single check was used to pay off several different customer accounts.
b. The company experienced extremely rapid growth even while its competitors’
growth was flat.
c. The company kept changing auditors every other year.
d. The bank account had been overdrawn on at least four occasions in one year.

38. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales,
Inc., a company that coated fabrics for use in producing things like parachutes, helmet
liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales
moved to the top of its industry, but ultimately the good times turned into bad times,
and the company declared bankruptcy. What happened to Weinstein?
a. After the bankruptcy, he raised new capital and started another fabric coating
company.
b. He was convicted, sentenced to prison, and ordered to make restitution.
c. He cooperated with the government and became an informant against his partners
who had been siphoning cash off of government contracts.
d. He was placed on probation after reimbursing the shareholders with the profits he
had made on investments in the stock market.