Midterm

Question 1

Which of the following is not a technique for recording revenue too soon?

a. Recording revenue when the buyer’s payment remains uncertain or unnecessary
b. Recording revenue on receipts from non-revenue-producing transactions
c. Recording revenue far in excess of work completed on the contract
d. Recording revenue before completing material obligations under the contract

Answer 1

b

Question 2

In the book and our discussions, recording revenue too soon generally involves legitimate sales where the timing of revenue recognition is manipulated. Which of the following are ways that companies can manipulate the timing of revenue recognition? Check all that apply.

Answer 2

Changing estimates such as the expected duration of a customer life on Roblox

Changing accounting policies such as destination point to shipping point (or vice versa)

Changing assumptions such as the customers’ ability to pay

Question 3

An agreement where a company records a sale to a customer, sends an invoice, but then does not ship the sale immediately is an example of what type of transaction?

a. Consignment sale
b. Sell-in agreement
c. bill and hold
d. sell-through agreement

Answer 3

c

Question 4

Under what scenario could a company recognize a sale while the buyer still has the ability to void the sale?

a. The order is full of incomplete products
b. The order is shipped too early
c. More goods than ordered were shipped to the customer
d. The company sets up an adequate return allowance on sales

Answer 4

d

Question 5

Which of the following are examples of recording bogus revenue?

Answer 5

Recording revenue on receipts from non-revenue-producing transactions

Recording revenue from appropriate transactions but at inflated amounts

Recording revenue from transactions that lack economic substance

Question 6

Consider a manufacturer of car tires. If the company is fraudulently making up sales (recording a sale that did not occur), what would you expect to see in other areas of the financial statements in the period of the fictitious sale?

a. An increase in accounts receivable
b. A decrease in accounts receivable
c. A decrease in inventory
d. An increase in cash

Answer 6

a

Question 7

In the late 1990s, AIG issued finite insurance policies to some clients. What was the purpose of the finite insurance policies?

a. Finite insurance policies “guaranteed” that the clients would have positive earnings.
b. Finite insurance policies transferred risks of missing earnings from clients to AIG.
c. Finite insurance policies covered clients from normal risks like natural disasters.
d. Finite insurance policies “insured” clients against earnings shortfalls.

Answer 7

d

Question 8

Which of the following is the most likely to be an arm’s length transaction?

a. A sale made to a relative of the CEO.
b. A sale made to a minority shareholder (<1%).
c. A sale made to a joint venture in which the company is 60% owner.
d. A sale made to a vendor.
e. A sale made to a minority shareholder (<1%).

Answer 8

b

Question 9

Which company recorded a short-term loan collateralized by inventory as a sale?

a. Enron
b. Groupon
c. Delphi
d. AIG

Answer 9

C

Question 10

Vendor rebates are cash received from a vendor/supplier for purchases made by a company. For example, if a company orders 1,000 units, a vendor may provide a cash-back rebate worth the value of 10 units. How should vendor rebates be treated by the company receiving them?

a. As revenue because cash was received and would not have been earned if not for purchasing the large amount
b. As a prepaid asset that can be applied to future purchases
c. As a reduction in the cost of the inventory purchased
d. As a liability that must be paid back to the supplier

Answer 10

c

Question 11

Which of the following is true regarding reporting revenue gross vs. net?

Answer 11

Reporting revenue gross is more likely to give the impression of higher sales than reporting revenue net.

Net income will always be the same whether reporting revenue gross or net.

Question 12

Enron recorded revenue on sales of financial instruments as net, while Groupon recorded revenue on sales deals as gross.

Answer 12

False

Question 13

Which of the following are techniques for recording bogus revenue? Check all that apply.

Answer 13

Boosting income through misleading classifications

Boosting income using one-time events

Question 14

Which of the following is not an example of a “one-time” event?

a. An unusually large sale of inventory to a customer
b. A divestiture
c. An acquisition
d. A sale of a large asset, like a manufacturing facility

Answer 14

a

Question 15

IBM sold part of their business for a gain of $4.1 billion. They included this gain as part of their Selling, General, and Administrative expense on the income statement (above the line). Which of the following occurred because of this decision. Check all that apply.

Answer 15

Operating expenses were understated.

Operating income was overstated.

Question 16

Which of the following is a way to shift expenses “below the line” on the income statement?

a. Inappropriately write off inventory
b. Fail to record transactions related to discontinued operations.
c. Understate the amount of restructuring reserves
d. Inappropriately fail to impair an asset

Answer 16

a

Question 17

Recurring restructuring costs is a warning sign that expenses have been shifted “below the line”.

T/F?

Answer 17

True

Question 18

Which of the following is a way to shift income “above the line” on the income statement?

a. Inappropriately record sales as investment income
b. Inappropriately record restructuring costs as part of cost of goods sold
c. Inappropriately record a portion of revenue as coming from discontinued operations
d. Inappropriately record investment income as part of sales

Answer 18

d

Question 19

Why are we concerned about companies using tricks to shift revenues and expenses above and below the line?

a. Because shifting these items will overstate or understate net income
b. Because shifting these items will overstate or understate EPS (earnings per share)
c. Because investors and other market participants often care about operating income

Answer 19

c

Question 20

Which of the following best describes Enron’s shenanigans discussed in this chapter?

a. Enron (or people affiliated with Enron) created special purpose entities that were then loaded with debt, took losses, and were consolidated (shown) on Enron’s financial statements.
b. Enron inappropriately shifted revenues below the line and expenses above the line.
c. Enron inappropriately shifted revenues above the line and expenses below the line.
d. Enron (or people affiliated with Enron) created special purpose entities that were then loaded with debt, took losses, and were not consolidated (not shown) on Enron’s financial statements.

Answer 20

d

Question 21

Which of the following is not a technique for shifting current expenses to a later period?

a. Failing to write down assets with impaired value
b. Amortizing costs too slowly
c. Excessively capitalizing normal operating expenses
d. Boosting income through misleading classifications

Answer 21

d

Question 22

All else equal, what is the effect of inappropriately capitalizing an expense?

a. Current period expenses will be lower
b. Current period assets will be lower
c. Current period expenses will be higher
d. Current period liabilities will be higher

Answer 22

a

Question 23

Why might a company increase the depreciation period of an asset from 10 years to 20 years?

a. To change the original recorded cost of an asset
b. To make annual depreciation expense lower
c. To keep the asset on the balance sheet for fewer years
d. To make annual depreciation expense higher

Answer 23

b

Question 24

Which of the following is the best example of a warning sign that a company is failing to record expenses for uncollectible accounts?

a. Accounts receivable is going up by 10% and the allowance for doubtful accounts is going up by 1%.
b. Accounts receivables is going up by 10% and the allowance for doubtful accounts is going up by 10%.
c. Accounts receivable is going down by 10% and the allowance for doubtful accounts is going up by 1%.

Answer 24

a

Question 25

What are the two components of free cash flows?

a. Cash flows from operations and capital expenditures
b. Cash inflows from operations and capital expenditures
c. Cash flows from investing and capital expenditures
d. Cash flows from operations and cost of goods sold

Answer 25

a

Question 26

Which of the following is not an example of employing other techniques to hide expenses or losses (according the Chapter 7)?

a. Recording inappropriately low expenses by using aggressive accounting assumptions
b. Failing to record an expense at the appropriate amount from a current transaction
c. Reducing expenses by releasing reserves from previous charges
d. Recording inappropriately high expenses from uncollectible receivables

Answer 26

d

Question 27

Potential losses from being sued might need to be recorded as loss contingencies. How can management manipulate the recording of these lawsuits to hide them from the income statement?

Answer 27

Management could inappropriately claim that they are unable to estimate the amount of potential loss

Management could inappropriately claim that they do not believe a loss is probable

Question 28

What about self-insurance policies and pension plans create fraud risks?

a. They are typically worth millions of dollars
b. They require significant estimates and assumptions to calculate their liabilities and expenses
c. They are typically found together (if a company has one, then they most likely have the other)
d. They may require the use of outside experts to calculate their liabilities and expenses

Answer 28

b

Question 29

What source is the most likely to provide detailed information on changes to reserve accounts, self-insurance policies, loss contingencies, and pension plans?

a. Statement of Other Comprehensive Income
b. News articles
c. Notes (footnotes) to the financial statements
d. Audit opinion

Answer 29

c

Question 30

The allowance for doubtful accounts and the warranty reserve are two examples of reserve accounts. Which of the following best describes their difference?

a. The allowance for doubtful accounts is created by incurring an expense, but the warranty reserve is not
b. The allowance for doubtful accounts is a liability reserve while the warranty reserve is an offset to assets
c. The allowance for doubtful accounts is an offset to assets while the warranty reserve is a liability reserve
d. The allowance for doubtful accounts cannot be used to manipulate earnings, but the warranty reserve can

Answer 30

c

Question 31

All else equal, what is the effect of releasing restructuring reserves from previous charges?

Answer 31

Net income is overstated
Expenses are understated

Question 32

Which of the following is an example of a technique to shift current income into a later period? Check all that apply.

Answer 32

Recording current period sales in a later period

Creating reserves in conjunction with an acquisition and releasing them into income in a later period

Creating reserves and releasing them into income in a later period

Question 33

Which of the following best describes “cookie jar accounting”?

a. Taking revenue that was not earned in the current year and recognizing it in the current year to help the company meet their revenue/income targets
b. Applying the accounting principle of conservatism appropriately in the current year
c. Taking a large expense/loss in the current period because the company was already going to take a net loss anyway
d. Taking revenue that was earned in the current year and deferring it to a later year when the company may need help meeting their revenue/income targets

Answer 33

d

Question 34

In the 1990’s it was alleged that Microsoft was inappropriately deferring a portion of its revenue to recognize it in a future year. Microsoft settled with an SEC Enforcement Action by neither admitting or denying the findings about their use of reserve accounting. What was speculated as a reason why Microsoft would want to defer their revenue?

a. Microsoft wanted to appear more profitable in the current year.
b. Microsoft may have wanted to avoid large revenue numbers when they were being investigated for anti-competitive behavior.
c. Microsoft may have been unsure that they would collect on their revenue, so they deferred it as a precaution
d. Microsoft wanted to defer their revenue to align with their expenses, even when the revenue had already been earned in the eyes of GAAP

Answer 34

b

Question 35

What is a warning sign that a company is reserving revenue so that it can be released in the future when it is needed?

a. Unusual reduction in unearned (deferred) revenue on the balance sheet combined with unusual growth in revenue on the income statement over time
b. Unusual growth in unearned (deferred) revenue on the balance sheet over time
c. A change in the types of products a company sells resulting in different revenue recognition policies
d. Unusual growth in revenue on the income statement over time

Answer 35

b

Question 36

At a high level, what did we discuss as a fraud risk associated with derivatives?

a. A company can use derivative accounting rules to improperly move derivative-related gains/losses off the income statement
b. Companies have the potential to lose money when using derivatives to manage risk
c. Derivatives allow companies to manage risks like changes in interest rates and foreign currency exchange rates
d. Derivative accounting allows companies to move derivatives off the balance sheet if used improperly

Answer 36

a

Question 37

Company A is a public company that has announced intentions to buy Company B, another public company. When reviewing Company B’s financial statements in the quarters before the deal is finalized, you notice a significant drop in sales. As someone on the lookout for financial shenanigans, what concern does this drop in sales raise?

a. Company B might be losing customers which could call into question whether Company A will want to complete the purchase of Company B
b. Company B might be inappropriately understating expenses as a way to get the highest price in the takeover by Company A
c. Company B might be understating reserves, such as the allowance for doubtful accounts, to appear to have higher-quality customers
d. Company B might be inappropriately understating sales leading up to the deal so that Company A can recognize them after the deal has been finalized, providing a boost in sales for the new combined company

Answer 37

d