Forensic Accounting and Fraud Examination 1st Edition Kranacher Test Bank
Forensic Accounting and Fraud Examination 1st Edition Kranacher Test Bank
Forensic Accounting and Fraud Examination 1st Edition Kranacher Test Bank
True/False
7-T/F #1. Management must design, implement, and maintain internal controls and financial
reporting processes to produce timely financial and nonfinancial information that
reflects the underlying economics of the business.
Answer: T
7-T/F #2. Management need not develop a methodology to measure their performance since
this is done with the released annual financial statements.
Answer: F
7-T/F #3. In very few cases will a company fall under the purview of more than one set of
regulations or taxing authorities influences.
Answer: F
7-T/F #4. Even though independent auditors are “independent,” management is still
responsible for cooperation in order for them to complete their work.
Answer: T
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7-T/F #5. “One-time” transactions of large values should be scrutinized to ensure they have
an appropriate underlying business rationale because generally such transactions
will be fraudulent.
Answer: F
7-T/F #6. An independent auditor’s “adverse” opinion on financial statements indicates the
auditors have completed their work and are concerned with the “going concern”
aspects of the audited entity.
Answer: F
7-T/F #8. Illegal acts have materiality thresholds and require that auditors pay close
attention to their nature and corresponding consequences to the company.
Answer: F
7-T/F #9. Earnings management below a threshold value may be judged immaterial.
Answer: T
7-T/F #10. Most audit committees have the authority to investigate any matters within the
scope of their responsibility, including internal control deficiencies, concerns
about the financial reporting process, suspected corruption, and alleged illegal
acts.
Answer: T
7-T/F #11. A major difference between auditors and fraud examiners is that most auditors
match documents to numbers to see whether support exists and is adequate,
whereas fraud examiners determine whether the documents are real or fraudulent..
Answer: T
7-T/F #12. The company should communicate its expectations and commitment to honest
and ethical behavior to vendors, suppliers, customers, contractors, and others who
do business with the organization.
Answer: T
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7-T/F #13. Common tipsters for fraud are employees, co-workers, managers, and outside
colleagues who interact with the fraudster daily, weekly, or monthly.
Answer: T
7-T/F #14. Unusual behaviors such as irritability or the inability to relax are examples of
analytical anomalies..
Answer: F
7-T/F #15. Most of a company’s information systems feed directly into the general ledger
and other aspects of the accounting system.
Answer: F
7-T/F #16. CAATTS (computer-aided auditing tools and techniques) are used primarily to
select samples and detect collusion .
Answer: F
7-T/F #17. The first step in the ten-step approach to targeted fraud risk assessment is
“Identify the business processes and consider differences in those processes in
foreign operations, as well as between subsidiaries and decentralized divisions.”
Answer: F
7-T/F #18. Data mining software such as Access, ACL, or IDEA allow a large amount of
data to be evaluated quickly for symptoms of fraud and provide evidence of the
fraud act or concealment of the fraud..
Answer: T
7-T/F #19. A fraudster, aided by the digital age, can easily minimize the amount of
information captured concerning his nefarious activities.
Answer: F
7-T/F #20. Electronic storage of entity financial and nonfinancial records is expensive and
access to the information in data warehouses is limited to data mining activities.
Answer: F
Multiple Choice
7-M/C #1. The Statement of Auditing Standards (SAS) No 1 states (select the most correct
answer):
A. management is responsible for adopting sound accounting policies and for
establishing and maintaining internal control consistent with
management’s assertions embodied in the financial statements.
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B. management is responsible for adopting sound accounting policies which
will result in adequate protection of entrusted assets.
C. management is responsible for adopting sound accounting principles
which will result in accurate and proper financial statements.
D. management is responsible for adopting sound internal control policies
which will protect entity assets from reasonable loss and damage.
Answer: A
7-M/C #4. In searching for breakdowns of internal controls by collusion and fraud, auditors:
A. should check all journal entries made on holidays, weekends, and late at
night.
B. should discuss with employees any journal entry which has been made to
reduce liabilities or increase owners’ equity.
C. should verify all journal entries and values associated with consolidations
which resulted for work within spreadsheets.
D. should obtain an understanding of the internal control processes regarding
journal entries and other adjustments.
Answer: D
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A. prior years’ estimates should be examined for consistency.
B. significant changes in estimating procedures are prohibited.
C. the concealment of fraud through estimates is hard since all estimates can
be directly tied to the individual responsible for them.
D. All of the choices are correct.
Answer: A
7-M/C #6. The public perception of independent auditors, particularly with regard to asset
misappropriation, corruption, and misstated financial statements, is that:
A. independent auditors have overcome the “expectations gap.”
B. an independent auditor’s responsibility is to provide reasonable assurance
that the financial statements are free from material misstatement whether
by error or fraud.
C. independent auditors are responsible for fraud detection.
D. audited financial statements are free of estimates and misstatements.
Answer: C
7-M/C #8. As a result of its significant concern with financial statement fraud, the
accounting profession responded in 2002 with:
A. SAS No. 1 – Consideration of Fraud in a Financial Statement Audit.
B. SAS No. 99 – Consideration of Fraud in a Financial Statement Audit.
C. the creation of the Public Company Accounting Oversight Board
(PCAOB).
D. guidance to overcome the “expectation gap” held by the public.
Answer: B
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D. All of the choices are correct.
Answer: B
7-M/C #11. SAS No. 99 lists several steps in considering the risk of fraud in a financial
statement audit. All of the following are correctly stated except:
A. Auditors must brainstorm with the key personnel of both the internal and
independent audit teams to plan a strategy to detect fraud.
B. Auditors must evaluate the audit evidence throughout the audit and
respond to any identified misstatements.
C. Auditors must determine the types of fraud risks that exist.
D. Auditors are required to report all fraud to an appropriate level of
management.
Answer: A
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7-M/C #14. Accounting principles and policies:
A. were designed to provide some degree of choice to management.
B. are”one-size-fits-all” to ensure comparability between companies.
C. preclude using GAAP compliant alternatives to manage income.
D. None of the choices are correct.
Answer: A
7-M/C #15. The primary responsibility to oversee management and direct the internal audit
and the external auditor with regard to the organization’s internal controls over
financial reporting and the company’s internal control processes rests with the:
A. external audit committee.
B. independent auditors.
C. president/CEO.
D. board of directors and/or the audit committee if one exists.
Answer: D
7-M/C #16. Audit committees generally have the right to all of the following except:
A. retain legal counsel, investigators, and forensic accountants.
B. take testimony of employees under oath.
C. retain nonauditor accountants.
D. retain other professional advisors as necessary to carry out their duties.
Answer: B
7-M/C #17. The main deterrent for fraud in the corporate environment:
A. remains the internal audit team.
B. remains the external audit team.
C. is the threat of getting caught.
D. is the effectiveness of the SEC and FBI investigators.
Answer: C
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B. should only continue their investigation if the fraud is in the present or
immediately previous period.
C. have an obligation to notify management or the board of directors when
the incidence of significant fraud has been established to a reasonable
degree of certainty.
D. must provide the audit committee and the board of directors with a
preliminary written statement detailing the known facts and presenting
reasonable suspicions as to perpetrators, values, methods, and time periods
affected.
Answer: C
A. I and II.
B. II and III.
C. I and III.
D. I, II, and III.
Answer: C
7-M/C #23. The second step to develop an approach to fraud detection is to:
A. develop an understanding of the control environment.
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B. develop a system of internal controls.
C. define the authority of the audit committee.
D. identify the members of internal audit and the audit committee.
Answer: A
7-M/C #24. Red flags, symptoms of fraud, often go unnoticed or are not vigorously pursued
because:
A. there is not supporting evidence of fraud.
B. the red flags are not associated with financial statement preparation.
C. there are many red flags in day-to-day operations that are not fraud
indicators.
D. the audit committee is involved in other investigations.
Answer: C
7-M/C #26. Some of the analytical anomalies include all of the following except:
A. transactions too small or too large for normal activity.
B. explained cash shortages.
C. excessive purchases.
D. excessive debit and credit memos.
Answer: B
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A. ensures that customers receive accurate and timely invoices.
B. ensures that vendors are paid accurately.
C. puts considerable emphasis on the system of internal controls.
D. All of the choices are correct.
Answer: C
7-M/C #29. Three of the various objectives of an internal control program are:
A. fraud prevention, fraud deterrence, and fraud mitigation.
B. fraud prevention, fraud deterrence, and fraud detection.
C. fraud deterrence, fraud detection, and fraud prosecution.
D. fraud elimination, fraud deterrence, and fraud mitigation.
Answer: B
7-M/C #30. The foundation behind the use of nonfinancial information for fraud detection is
that:
A. prenumbered forms function as fraud deterrents.
B. the more data available, the harder it is to conceal fraud.
C. every accounting event has a quantity of units associated with it.
D. the world revolves around quantities and prices.
Answer: D
7-M/C #31. When using red flags as a basis for further investigation:
A. each fraud will have some unique attributes.
B. each fraud has common elements making identification easier.
C. red flags prove of very limited value due to their massive number in day-
to-day operations.
D. All of the choices are correct.
Answer: A
7-M/C #33. Targeted fraud risk assessment is consistent with the PCAOB’s Auditing Standard
No. 5 (AS5) which:
A. requires a top down approach.
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B. requires the audit team to hold a brainstorming session at the beginning of
each investigation to determine who has the ability to commit the potential
fraud.
C. requires the board of directors to review the internal controls of the entity
when fraud of a material amount is detected.
D. requires the audit committee report directly to the independent auditor.
Answer: A
7-M/C #35. The key to successful fraud detection and investigation using digital tools and
techniques requires:
A. a systems-type approach.
B. a targeted approach.
C. a results-driven approach.
D. access to data warehouses and data mining tools such as Access, ACL, or
IDEA.
Answer: B
7-SAE #2. Provide at least five examples of typical internal control weaknesses.
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Answer: (Answers may include weaknesses not identified here.) Typical internal control
weaknesses include:
1. Lack of segregation of duties.
2. Lack of physical safeguards.
3. Lack of independent checks.
4. Lack of proper authorization.
5. Lack of proper documentation and other records.
6. Override of existing internal controls.
7. Inadequate accounting system.
8. Inadequate employee education (expectations).
9. Reactive fraud detection approach.
10. Inadequate surprise audits.
11. Inadequate whistleblower opportunities and protection.
7-SAE #3. It is said the nonfinancial numbers are powerful tools for the fraud examiner.
Explain why and provide examples of how.
Answer: (Answers will vary but should generally follow the concept as stated in the text.)
Businesses frequently deal in quantities with extended costs or price for many
events. If one hundred cans of red paint are purchased for five dollars each as
initial inventory, for sale at nine dollars each and eight are documented as sold,
ninety-two should be remaining. If ninety-four or ninety are in the physical
inventory count extended inventory values of ($5 × 92) four hundred and sixty
dollars is not justified and the declaration of sales of ($9 × 8) seventy-two dollars
comes under suspicion.
A warehouse concept with eight part-time employees would be an issue to
investigate if the site recorded (8 workers × 40 hours) three hundred and twenty
hours worked each weekly pay period.
7-SAE #4. Red flags are considered trouble signs in almost any environment and yet there
seem to be many red flags in normal business operations which can reduce their
value in finding fraudulent activities. Explain how this may happen.
Answer: (Answers will vary but should generally follow the concept as stated in the text.)
The normal business events of purchasing, selling, paying creditors, and paying
employees will seldom generate red flags. However, when a customer requests a
credit on his account for damaged goods or the warehouse reports merchandise
damaged or destroyed in a movement digital systems commonly portray these as
abnormal, red flag, events. When vendors are paid late or debit memos are issued
to vendors additional red flag events may be recorded.
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Additionally, payables that are due every thirty days starting on January 1, will be
paid three times in the first, third, and fourth quarters and four times in the second
quarter of a non-leap year. This additional payment may appear as a red flag.
7-SAE #5. The fraud examiner categorizes schemes in three ways, Category 1, Category 2,
and Category 3. Explain each category.
Answer: Category 1—Wrongdoing perpetrated by an insider acting alone with the
principal benefit to the individual (examples include simple, one-person, garden-
variety embezzlement schemes)
Category 2—Wrongdoing perpetrated by more than one individual acting
collusively (possibly with individuals outside the company) with the principal
benefit to the individual perpetrators or the organization (examples include
sophisticated asset misappropriation, corruption, and/or financial statement fraud)
Category 3—Wrongdoing perpetrated by an outside third party against the
organization with the principal benefit to the third party (examples include the
sales of inferior goods that do not meet contract specifications)
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7-TRQ #2. Generally, how is the problem of management override and collusion addressed?
Answer: Depending on the individuals involved, internal controls cannot prevent
management override or collusive behavior by and among senior management.
Since prevention (segregation of duties, approvals and authorizations) is not
possible in a collusive environment, the principal internal control procedures will
be centered on detection. The fear of detection may be an effective deterrence
mechanism, but that does not eliminate the concern that traditionally designed
internal control systems centered on prevention will not be effective when
management override or collusion is present. Thus, internal and external auditors,
fraud examiners, and forensic accounting professionals must design procedures to
detect such activity.
7-TRQ #4. What is the role of the external auditor in the financial reporting process?
Answer: The auditor’s role is to attest to the fairness of management’s presentation of the
financial information as well as the assertions inherent in the financial statements.
When auditors have completed their work, they report their findings in an audit
report.
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impact on the information presented in the financial statements. Further, auditors
rely not only on financial assessments, they also consider various qualitative
factors such as whether they have discovered fraud in prior audits or there are
allegations of illegal acts or fraud. Generally, illegal acts have no materiality
threshold and require that auditors pay close attention to their nature and
corresponding consequences to the company.
7-TRQ #7. What are some red flags that may indicate that fraud is occurring?
Answer: The red flags that can lead to a formal fraud investigation include tips and
complaints, behavioral red flags, analytical anomalies, accounting anomalies and
internal control irregularities and weaknesses.
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7-TRQ #9. What are the similarities and differences between analytical and accounting
anomalies?
Answer: Anomalies are based on patterns or breaks in patterns. Analytical anomalies are
transaction or financial statement relationships that do not make sense, such as:
• Unexplained cash shortages
• Unexplained inventory shortages
• Deviations from specifications
• Increased scrap
• Excessive purchases
• Too many debit memos
• Too many credit memos
• Significant unexpected changes in account balances
• Excessive late charges
• Unreasonable expenses
• Unusual expense reimbursements
7-TRQ #10. What are the main components of the fraud risk assessment process?
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Answer: An overview of the fraud risk assessment process includes the following
components:
• Evaluate the fraud risk factors
• Identify possible fraud schemes and scenarios
• Prioritize individual fraud risks
• Evaluate mitigating controls for those fraud schemes that are reasonably
possible or probable of occurrence and are more than inconsequential or
material.
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