Deck 7: Fraud and Earnings Management

Question 1

To curb potential abuse,publicly traded companies:

A) May not do business with related parties
B) May not have related parties serve on their Boards of Directors
C) May do business with related parties, as long as such relationships and transactions are clearly disclosed
D) May do business with related parties as long as such transactions occur at fair market value, as determined by the company's independent auditors

Answer 1

C

Question 2

"Big bath accounting" describes a company's actions when it:

A) Manages its earnings in a downward direction in the year of a major acquisition or restructuring
B) Optimizes the amount of Goodwill recognized upon paying a premium to acquire another company
C) Manages its earnings by maintaining such a large number of discretionary items that it could "fill a bathtub," so to speak
D) "Cleans its books," so to speak, of improperly recorded items in anticipation of a rigorous audit examination

Answer 2

A

Question 3

Enron's use of Special Purpose Entities led to:

A) Widespread, and wholly unexpected, embezzlements of funds
B) Widespread embezzlements of funds that could had, and should have, been readily anticipated
C) The accounting profession developing the concept of consolidated financial statements
D) Rule changes in GAAP

Answer 3

D

Question 4

The Fraud Triangle refers to:

A) The three acts of accounting deception that led to Enron's downfall
B) The three alternative causes of fraud in large organizations
C) The three alternative causes of financial fraud in business enterprises
D) The three elements that collectively must be present for fraud to occur

Question 5

Your employer operates in an industry in which company pre-tax earnings are expected to increase by 5% next year.Your employer,however,has issued earnings guidance in which it declared that it expects its pre-tax earnings to increase by 11% next year.As a result,which of the following elements of the Fraud Triangle are present?

A) Attitudes
B) Pressure to understate expenses
C) Opportunity to overstate revenues
D) All three elements are present

Question 6

From the perspective of accounting,the downfall of Lehman Brothers was primarily attributable to:

A) The company's undue focus on short-term earnings
B) The company's blatantly deceptive revenue recognition policy on complex financial products and services
C) Debt repayment transactions that lacked enduring economic substance
D) A subtle variation on cookie jar accounting

Question 7

A "side agreement":

A) Allows a company to charge a lower selling price to attract a new customer, without existing customers discovering this reduction
B) A secondary agreement that overrides a primary agreement, for the purposes of committing accounting fraud
C) An comparatively minor agreement that forensic investigators set aside during the course of conducting a fraud examination of major improprieties
D) A technique used by Certified Fraud Examiners and others to deter potentially fraudulent actions

Question 8

When a person's net cash flow exceeds his reported taxable income,the presumption that this individual has misreported his income to taxing authorities can be rebutted by showing that:

A) The cash flow was attributable to the receipt of a nontaxable inheritance
B) The cash flow was attributable to loan proceeds
C) The cash flow was attributable to the receipt of nontaxable gifts
D) All of the above

Question 9

According to the Fraud Triangle,which the following is one of the requisites for fraud to occur?

A) The perception of an opportunity for ill-gotten financial gain
B) The existence of sound justification for a person to receive greater financial rewards
C) The existence of a clear-cut opportunity for ill-gotten financial gain
D) Employment in a sensitive financial capacity in which peers reap greater financial rewards than the employee contemplating fraud receives

Question 10

The LIBOR scandal was primarily caused by:

A) Bad debt losses on bank loans that were biased downward to avoid inquiry by European banking regulators
B) Excessive reliance by banks on loans the bear adjustable loan interest rates
C) A lack of candor by certain banks
D) A lack of integrity by large corporate borrowers

Question 11

"Cookie jar accounting":

A) Always sweetens, or increases, a company's reported profits, as its name suggests
B) Sets aside questionable but desirable items in a jar, so to speak, and reports conservative results
C) Allows a firm to manipulate the trend in its earnings, making earnings less volatile
D) Allows a firm to boost its long-run, total reported earnings from a financial accounting perspective

Question 12

When a person's net cash flow exceeds his or her reported taxable income,the IRS:

A) Has an automated system that identifies a taxpayer as a possible tax cheater
B) Presumes, upon examination, that the taxpayer is underreporting his or her income
C) Conclusively recognizes that the taxpayer is underreporting his or her income
D) Conclusively recognizes that the taxpayer has underreported both income and tax payments

Question 13

Enron used special-purpose entities to:

A) Keep large amounts of debt off of its balance sheet
B) Create the appearance of activities that fooled inspectors
C) Distort its reported Accounts Receivable
D) Avoid the use of accelerated depreciation on assets for which this method was required to be applied

Question 14

Your employer operates in an industry in which company sales are expected to increase by 5% next year.Your employer,however,has issued earnings guidance in which it declared that it expects its sales to increase by 13% next year.As a result,which of the following elements of the Fraud Triangle are present?

A) Rationalization
B) Pressure to engage in channel stuffing
C) Opportunity to exceed expectations
D) Opportunity to garner above-market stock performance gains

Question 15

Which of the following scandals can best be described as a Ponzi scheme?

A) The Madoff scandal
B) The Healthsouth scandal
C) The Krispy Kreme scandal
D) All of the above

Question 16

Which of the following is not an element of The Fraud Triangle?

A) A person's attitude
B) A person's willingness to violate the Due Care Principle
C) The presence of pressures to achieve specified performance levels
D) The perceived opportunity for financial gain

Question 17

"Round trip" transactions primarily are utilized by companies:

A) To commit tax fraud
B) To substantially change the overall composition of their assets
C) To recognize accounting gains without meaningfully changing the nature of their operations
D) To return capital that previously was contributed by shareholders, often through the use of treasury stock repurchases

Question 18

Some commentators have suggested that Enron would not have collapsed if it:

A) Had enacted a Code of Conduct
B) Had enacted a standard Code of Conduct rather than the weak one that it in fact had
C) Had carefully complied with all of the provisions of the Sarbanes-Oxley Act
D) Had not unduly focused on short-term stock performance

Question 19

Which of the following scandals involved expenses that were improperly were capitalized as assets?

A) World Com
B) Parmalat
C) Bernie Madoff
D) Enron

Question 20

By serving on the Board of Directors of various charities,Bernie Madoff was able to:

A) Utilize their tax-exempt status to his advantage
B) Invest funds in a nontaxable manner
C) Hide his profits through the use of nonprofit organizations that were highly unlikely to be audited by the IRS
D) Gain their trust

Question 21

What is big bath accounting? How is it abused?

Question 22

What lessons have been learned from the demise of Enron?

Question 23

A North Dakota telecommunication company sold "the contractual right to a 5-year supply of transmission capacity" to another telecommunication company in an all-cash transaction.The price was deliberately set above fair market value.The buyer,located in San Jose,California,in turn sold an equivalent amount of "5-year transmission capacity" to the North Dakota telecommunications company at an equally inflated price in an all-cash transaction.
a. Does this affect the North Dakota companies' net cash flow?
b. Does it affect the North Dakota company's reported assets?
c. Does it affect the North Dakota company's revenues in the year of sale?
d. Does it affect the North Dakota company's long-term profitability?
e. Why do you think that this company entered into this transaction?
f. Would you describe this transaction as a "round-trip" transaction? Why or why not?
g. How can auditors ensure that abusive transactions such as this one do not deceive the investing public?

Question 24

If the accounting profession were to replace the accrual basis of accounting with the cash basis,do you think that financial accounting fraud would increase or decrease? Defend your viewpoint.

Question 25

What is cookie jar accounting? How is it abused?