Forensic Chapter 4 Textbook Questions

What forensic technique was used by Coca-Cola to prosecute the secretary who was convicted for attempting to sell product information to Pepsi? a. invigilation b. interviews c. videotape d. net worth method e. horizontal analysis

videotape

What are some of the requirements for audit committees under the Sarbanes-Oxley Act?

•Each member of the audit committee of the issuer must be independent according to specified criteria and at least one member should have an accounting background; •The audit committee of each issuer must be directly responsible for the appointment, compensation, retention, and oversight of the work of any registered public accounting firm engaged for an audit report and such accounting firm must report directly to the audit committee; •Each audit committee must establish procedures for complaints on accounting, internal accounting controls, or auditing matters (e.g., a hotline); •Each audit committee must have the authority to engage independent counsel and other advisors, as it determines necessary to carry out its duties; •Each issuer must provide appropriate funding for the audit committee; and •With a few exceptions, listed issuers must be in compliance with the new listing rules by the earlier of (1) their first annual shareholders meeting after January 15, 2004, or (2) October 31, 2004."

What is the key question that an auditor should ask according to the Panel on Audit Effectiveness?

"Where is the entity vulnerable to financial statement fraud if management were inclined to perpetuate it?"

What are pro formas?

- Pro forma financial statements could be designed to reflect a proposed change, such as a merger or acquisition, or to emphasize certain figures when a company issues an earnings announcement to the public. - Investors should be careful when reading a company's pro-forma financial statements, as the figures may not comply with generally accepted accounting principles (GAAP). In some cases, the pro-forma figures may differ greatly from the those derived from GAAP. http://www.investopedia.com/terms/p/proforma.asp

Using the facts in problem 21, the operating margin is: a. .1125 b. .32 c. 1.1 d. 1.6 e. None of the above

.1125

The following information is taken from the accounting records of Donald Company. Average receivables.............................$700,000 Cost of goods sold...............................$2,900,000 Sales......................................................$8,000,000 Average inventory...............................$1,100,000 Net credit sales....................................$1,200,000 Operating income...............................$900,000 The inventory turnover is: a. 1.81 b. 2.2 c. 2.64 d. 2.92 e. None of the above

2.64

What is meant by "more than remote"?

5% highly unlikely

What is vertical analysis?

A method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities and equities) in a balance sheet is represented as a proportion of the total account. The main advantages of vertical analysis is that the balance sheets of businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes within one business. http://www.investopedia.com/terms/v/vertical_analysis.asp

What is horizontal analysis?

A procedure in fundamental analysis in which an analyst compares ratios or line items in a company's financial statements over a certain period of time. The analyst will use his or her discretion when choosing a particular timeline; however, the decision is often based on the investing time horizon under consideration. http://www.investopedia.com/terms/h/horizontalanalysis.asp

a scheme in which businesses collude so that a competing business can secure a contract for goods or services at a pre-determined price. Bid rigging stifles free-market competition, as the rigged price will be unfairly high. The Sherman Act of 1890 makes bid rigging illegal under U.S. antitrust law. Bid rigging is a felony punishable by fines, imprisonment or both.

Bid rigging

the strategy of manipulating a company's income statement to make poor results look even worse. The big bath is often implemented in a bad year to enhance artificially next year's earnings. The big rise in earnings might result in a larger bonus for executives. New CEOs sometimes use the big bath so they can blame the company's poor performance on the previous CEO and take credit for the next year's improvements.

Big bath

refers to a company's net earnings, net income or earnings per share (EPS). Bottom line also refers to any actions that may increase/decrease net earnings or a company's overall profit. A company that is growing its net earnings or reducing its costs is said to be "improving its ________________."

Bottom line

What internal control framework is used most often in the U.S.? a. Auditing Standard No. 2 b. SAS No. 99 (AU 316) c. COBIT d. COSO e. Some other framework

COSO

distributors temporarily beef up their accounts receivables. However, unable to sell the excess products, retailers will send the excess items instead of cash back to the distributor, who must readjust its accounts receivable and ultimately its bottom line. In other words, stuffing always catches up with the company, because it cannot maintain sales at the rate it is stuffing.

Channel stuffing

What public document reviews may be helpful to a forensic accountant?

Civl suits, criminal records, tax records, mortgages

Under the updated COSO Cube, which is not considered to be one of the five components? a. control environment b. monitoring c. risk assessment d. control activities e. none of the above

Control environment

define

Control risk

A forensic account determines the following facts about a Delta company: Cash and equivalents................................$76,000 Receivables.................................................$218,000 Current assets............................................$420,000 Current liabilities.......................................$240,000 Average inventory.....................................$310,000 Cost of goods sold....................................$580,000 Advertising expenses...............................$255,000 Calculate the current ratio

Current ratio - 1.75

Why are Cynthia Cooper and Scott Sullivan significant in detecting financial reporting fraud?

Cynthia Cooper uncovered the biggest accounting scam in U.S. history—at least $3.8 billion (eventually $11 billion).

define

Detection Risk

What is a red flag with respect to earnings?

Downward trend in earnings is a red flag with respect to earnings.

is all profits before taking into account interest payments and income taxes. An important factor contributing to the widespread use of ______ is the way in which it nulls the effects of the different capital structures and tax rates used by different companies. By excluding both taxes and interest expenses, the figure hones in on the company's ability to profit and thus makes for easier cross-company comparisons.

EBIT

essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

EBITDA

Why might management be interested in forensic accounting services?

Executives can be in trouble if they are in a position to detect wrongdoing below them and do not move forcefully to prevent the fraud.

In order to determine how risky a particular company is that you are auditing, you prepare these five ratios along with the same ratios of this company's peers: COMPANY PEERS Day's Sales in Receivable Index 1.51 1.05 Gross Margin Index 1.98 1.11 Asset Quality Index 1.21 1.01 Sales Growth Index 1.53 1.19 Total Accruals to Total Assets .11 .06 What are your thoughts about the risk potential of this company?

False receivables, fictitious sales

How does a forensic accountant analyze inventories and receivables?

Forensic accountant analyze inventories and receivables by looking at the ratio of accounts receivable to sales and the ratio of inventory to cost of goods sold.

Are the GAAS audit standards designed to catch fraud other than financial statement fraud? What is the expectation gap? Did SAS No. 99 close it?

GAAS audit standards are NOT designed to catch fraud other than financial statement fraud. There is a gap between public expectations and the product that independent auditors deliver. SAS No. 99 did a big step to close it.

How should inventory, sales, and receivables move in a typical company?

In tandem

What are some of the main points of SAS No. 99?

Increased Emphasis on Professional Skepticism, Discussions with Management, Unpredictable Audit Tests, Responding to Management Override of Controls, Brainstorming.

define

Inherent Risk

What is the Institute of Internal Auditors' definition of internal auditing?

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.

What is the internal auditor's task with respect to fraud? Who has primary responsibility?

Internal auditors are not responsible for finding fraud on the job. Management has the primary responsibility

Using the info in #25, calculate the inventory turnover

Inventory turnover - 1.87

What does Lee Seidler say about external auditors? What overcomes the assumption that separation of duties prevents fraud?

Lee Seidler says that "No major fraud has ever been discovered by auditors." "He believes that auditors will continue to miss fraud because much of their work is predicated on the assumption that separation of duties prevents fraud."

Who is responsible for internal controls? a. external auditors b. internal auditors c. management d. audit committee e. board of directors

Management

define

Materiality

Which statement is false? a. SAS No. 99 does not prohibit clients from preparing confirmations b. Enron issued $1.2 billion of stock to an SPE and recorded a $1.2 billion notes receivable c. Most of WorldCom's original entries for online costs were properly placed into expense accounts d. Materiality is not important for an external auditor e. For prosecution for fraud, an accountant needs to find scienter (knowingly)

Materiality is not important for an external auditor

A form of financing in which large capital expenditures are kept off of a company's balance sheet through various classification methods. Companies will often use off-balance-sheet financing to keep their debt to equity (D/E) and leverage ratios low, especially if the inclusion of a large expenditure would break negative debt covenants.

Off-balance-sheet financing

What is the Public Company Accounting Oversight Board (PCACOB)?

PCACOB is a five-member oversight group, which regulates auditors of public companies, sets auditing standards, and investigates violations.

Using the info in #25, calculate the quick ratio

Quick ratio - 0.46

Using the info in #25, calculate the working capital

Working capital - 180,000.00

Which of these statements is false to auditing standards? a. a high degree of competition accompanied by declining margins would be an example of an opportunity for fraudulent financial reporting b. Personal guarantees of debt of a company that are significant to one's personal net worth are an example of a pressure/incentive for fraudulent financial reporting c. A heavy concentration of one's wealth in a particular company would be an example of a rationalization condition for fraudulent financial reporting d. An excessive interest by management in maintaining a company's stock price is an example of rationalization for fraudulent financial reporting e. An anticipated future layoff would be an example of one incentive to misappropriate assets f. a large amount of cash on hand would be an example of a rationalization to misappropriate assets. g. Inadequate internal controls are an example of an opportunity to misappropriate assets

a. a high degree of competition accompanied by declining margins would be an example of an opportunity for fraudulent financial reporting c. A heavy concentration of one's wealth in a particular company would be an example of a rationalization condition for fraudulent financial reporting - incentive/pressure f. a large amount of cash on hand would be an example of a rationalization to misappropriate assets. - opportunity

________ __________ refers to a company pulling revenues into the distribution channel fraudulently. a. constructive intent b. channel stuffing c. gaming strategy d. big bath e. double play

channel stuffing

A disingenuous accounting practice in which periods of good financial results are used to create reserves that shore up profits in lean years. "Cookie jar accounting" is used by a company to smooth out volatility in its financial results, thus giving investors the misleading impression that it is consistently meeting earnings targets. This reliable earnings performance is generally rewarded by investors, who assign the company a premium valuation. Regulators frown on the practice since it misrepresents a company's performance, which may be very different in reality from what it purports to be.

cookie jar accounting

A buzzword describing fraudulent activities performed by corporations in order to falsify their financial statements. Typically, _____________ involves augmenting financial data to yield previously non-existent earnings. Examples of techniques involve accelerating revenues, delaying expenses, manipulating pension plans and implementing synthetic leases.

cooking-the-books

Which statement is false with respect to SAS No. 99? a. SAS No. 99 supersedes SAS No. 82. b. An audit procedure to address the risk of management override would include examining journal entries and other adjustments. c. The management characteristics category in SAS No. 82 is significantly more important than those in the other two SAS No. 82 categories. d. Unlike errors, fraud is intentional and usually involves deliberate concealment of the facts e. none of the above

none of the above

What would not be an abusive earnings management scheme according to the SEC? a. a big bath b. channel stuffing c. postponing repairs and maintenance expenses d. Cookie-jar accounting e. a and c above

postponing repairs and maintenance expenses