Chapter 10

Question 1

Fraudulent Financial Reporting

Answer 1

An intentional misstatement or omission of amounts or disclosures with the intent to deceive users.

Question 2

Most cases involve either:

Answer 2

1. An attempt to overstate income.

2. Earnings management involves committing fraud to meet earnings goals.

Question 3

The Committee of Sponsoring Organizations (COSO) found that _______ of financial statement frauds involve revenue and accounts receivable.

Answer 3

more than half

Question 4

Three main types of revenue manipulation are:

Answer 4

a. Fictitious revenues
b. Premature revenue recognition
c. Manipulation of adjustments to revenue.

Question 5

Income smoothing

Answer 5

is a form of earnings management that shifts income from year to year to reduce fluctuations.

Question 6

Misappropriation of Assets

Answer 6

Fraud that involves theft of an entity’s assets.

Question 7

Normally, this type of fraud is perpetrated by_____, and it rarely is as material as fraudulent financial reporting.

Answer 7

lower level employees but can involve upper management

Question 8

Misappropriation of assets often involves

Answer 8

failure to record a sale and theft of cash receipts after a sale is recorded.

Question 9

Use professional skepticism:

Answer 9

Questioning mind and critical evaluation of evidence.

Question 10

The AICPA identifies three elements to prevent, deter, and detect fraud:

Answer 10

1. Culture of honesty and high ethics
2. Management’s responsibility to evaluate risks of fraud
3. Deterrence created by audit committee oversight

Question 11

Culture of honesty and high ethics (prevent list 6)

Answer 11

a. Setting the tone at the top
b. Creating a positive workplace environment:
c. Hiring and promoting appropriate employees
d. Training regarding the company’s expectations of ethical conduct
e. Periodic confirmation by employees of their ethical responsibilities
f. Discipline/Enforcement

Question 12

Management’s responsibility to evaluate risks of fraud (deter list 3)

Answer 12

a. Effective fraud oversight
b. Design and implement controls to mitigating fraud risk
c. Monitoring fraud prevention programs and controls

Question 13

Deterrence created by audit committee oversight (detect list 3)

Answer 13

a. Direct reporting of key findings by internal auditors to the audit committee
b. Periodic reports by ethics officers about whistleblowing
c. Other reports about lack of ethical behavior or suspected fraud

Question 14

Revenue and Accounts Receivable Fraud Risks.

Answer 14

Auditing standards require that the auditor presume there is a risk of fraud in revenue recognition.

Question 15

Two of the most useful warning signs are of Revenue and Accounts Receivable fraud:

Answer 15

a. Analytical procedures

b. Documentary discrepancies.

Question 16

Purchases and Accounts Payable Fraud Risks—

Answer 16

Companies may deliberately attempt to understate accounts payable and overstate income.

The most common type of fraud involving misappropriation of assets in the acquisition area is for payments to be issued to fictitious vendors and depositing the cash in fictitious accounts.

Question 17

Other Areas of Fraud Risk ( list 3)

Answer 17

1. Fixed Assets
2. Intangible Assets
3. Payroll Expense

Question 18

Fixed Assets—

Answer 18

Companies may capitalize repairs to increase the amount of assets on the balance sheet.

Question 19

Intangible Assets—

Answer 19

The values of intangible assets, especially goodwill, are based on estimates and are susceptible to manipulation.

Question 20

Payroll Expense—

Answer 20

Rarely an area for fraudulent financial reporting, but often an area of misappropriation by payment to fictitious employees or overstatement of payroll hours.

Question 21

Auditors must document the following matters related to consideration of material misstatements due to fraud: (list 7)

Answer 21

1. Significant decisions made during the discussion among engagement team in planning the audit
2. Procedures performed to obtain information necessary to identify and assess the risks of material fraud
3. Specific risks of material fraud that were identified at both the overall financial statement level and the assertion level and the auditor’s response to those risks
4. Reasons supporting a conclusion that there is not a significant risk of material improper revenue recognition
5. Results of procedures performed to address the risk of management override of controls
6. Other conditions and analytical relationships indicating that additional auditing procedures or other responses were required, and the actions taken by the auditor in response
7. The nature of communications about fraud made to management, the audit committee, or others