Chapter 12 –Financial Statement Fraud Schemes

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.