Deck 7: Fraud Detection: Red Flags and Targeted Risk Assessment

Question 1

"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 1

False

Question 2

FASB 2 defines materiality as the "magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement."

Answer 2

True

Question 3

Even though independent auditors are "independent," management is still responsible for cooperation in order for them to complete their work.

Answer 3

True

Question 4

Common tipsters for fraud are employees, co-workers, managers, and outside colleagues who interact with the fraudster daily, weekly, or monthly.

Question 5

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."

Question 6

Earnings management below a threshold value may be judged immaterial.

Question 7

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..

Question 8

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.

Question 9

Illegal acts have materiality thresholds and require that auditors pay close attention to their nature and corresponding consequences to the company.

Question 10

A fraudster, aided by the digital age, can easily minimize the amount of information captured concerning his nefarious activities.

Question 11

Most of a company's information systems feed directly into the general ledger and other aspects of the accounting system.

Question 12

CAATTS computer-aided auditing tools and techniques are used primarily to select samples and detect collusion .

Question 13

Electronic storage of entity financial and nonfinancial records is expensive and access to the information in data warehouses is limited to data mining activities.

Question 14

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..

Question 15

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.

Question 16

Management need not develop a methodology to measure their performance since this is done with the released annual financial statements.

Question 17

Unusual behaviors such as irritability or the inability to relax are examples of analytical anomalies..

Question 18

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.

Question 19

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.

Question 20

In very few cases will a company fall under the purview of more than one set of regulations or taxing authorities influences.

Question 21

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.

Question 22

The difference between fraud and errors is:

A) the materiality of the value involved.
B) intent of those involved.
C) whether it affects owners' equity or not.
D) All of the choices are correct.

Question 23

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.

Question 24

With regard to the review of accounting estimates:

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.

Question 25

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.

Question 26

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.
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.

Question 27

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.

Question 28

Earnings management may:

A) increase current period net income.
B) decrease current period net income.
C) may involve "consuming" prior period reserves for current period performance.
D) All of the choices are correct.

Question 29

Upon discovering fraud, internal auditors:

A) must fully investigate it and determine perpetrators, value, damage, and recommend possible action.
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.

Question 30

Fraud can be committed by:

A) intentional misapplication of accounting principles that guide the disclosure of financial information.
B) omission of events, transactions, or other significant information in the notes related to the financial statements.
C) alteration of the underlying accounting data.
D) All of the choices are correct.

Question 31

In a collusive environment:

A) management is responsible for all acts of fraud.
B) the fear of detection is usually more than adequate to stop fraud by senior management.
C) internal and external auditors must design procedures to detect such activity.
D) All of the choices are correct.

Question 32

Overall, management must design, implement, and maintain:

A) an internal controls program to protect entity assets, liabilities, and owners' equity.
B) internal controls and financial reporting processes to produce timely financial and nonfinancial information that reflects the underlying economics of the business.
C) an accounting system that is in full compliance with U.S. GAAP accounting principles.
D) All of the choices are correct.

Question 33

Anomalies are:

A) most often red flags that indicate fraud is present.
B) part of the day-to-day operations for most companies.
C) seldom seen in companies with good internal controls and procedures.
D) Both "A" and "C" are correct.

Question 34

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.

Question 35

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.

Question 36

As related to operations, the internal auditors evaluate:

A) division profitability.
B) product line profitability.
C) segment profitability.
D) All of the choices are correct.

Question 37

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.

Question 38

Materiality is relative. As such:

A) the amount of stockholders' equity is used as a base.
B) the type of account and its related financial statement plays an important role in materiality.
C) net income is more critical than total revenues or total expenses.
D) materiality threshold values should be increased where management barely qualifies for bonuses and other short-term compensation.

Question 39

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.

Question 40

An auditor's opinion of:

A) "unqualified" indicates that there are major problems with the financial statements presented by management.
B) "unqualified" indicates that the independent auditors believe the financial statements presented by management are fairly presented.
C) "qualified" indicates that the independent auditors believe the financial statements presented by management meet the guidance of U.S. GAAP.
D) All of the choices are correct..

Question 41

The second step to develop an approach to fraud detection is to:

A) develop an understanding of the control environment.
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.

Question 42

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.

Question 43

The first step to detecting fraud is to:

A) build an internal control system.
B) establish an audit committee and identify its authority.
C) seek out red flag transactions and possible anomalies.
D) build an understanding of the organization and the environment in which it operates.

Question 44

Define the terms fraud prevention, fraud deterrence, and fraud detection and identify issues of timing.

Question 45

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.

Question 46

The 2008 biennial ACFE Report to the Nation:

A) shows that almost half, 46.2 percent, of the frauds are detected by accident.
B) shows that frauds detected or exposed by tips and accident total almost 55 percent of the frauds discovered.
C) shows that tips and internal controls are the two largest identifiers for fraudulent activities.
D) shows that fraud exposed by accident has increased in the last two years from 20 percent to approximately 25.4 percent.

Question 47

The Sarbanes-Oxley Act of 2002, in particular section 404:

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.

Question 48

Provide at least five examples of typical internal control weaknesses.

Question 49

It is said the nonfinancial numbers are powerful tools for the fraud examiner. Explain why and provide examples of how.

Question 50

Targeted fraud risk assessment is consistent with the PCAOB's Auditing Standard No. 5 AS5 which:

A) requires a top down approach.
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.

Question 51

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.

Question 52

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.

Question 53

Journal entries of concern include:

A) entries made by accounting personnel.
B) entries made by members of senior management.
C) routine accrual entries prepared at year-end.
D) All of the choices are correct.

Question 54

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.

Question 55

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.

Question 56

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.

Question 57

The major approaches to fraud detection are through:
I. Red flags that ultimately point to problems underlying the foundation upon which transactions are recorded.
II. Whistleblowers.
III. Targeted risk assessment.

A) I and II.
B) II and III.
C) I and III.
D) I, II, and III.

Question 58

Information systems:

A) as a mechanism for fraud prevention, deterrence, and detection cannot be overstated.
B) usually provide weak evidence trails due to their digital nature.
C) can be used to reconstruct actual data flow of considerable value to the fraud specialist.
D) generate small amounts of red flags, each of which requires further investigation.

Question 59

The fraud examiner categorizes schemes in three ways, Category 1, Category 2, and Category 3. Explain each category.

Question 60

Targeted fraud risk assessment starts with:

A) a hotline or anonymous tip.
B) the observance of an individual living above his income.
C) a solid knowledge, skill, and ability in fraud detection and investigation.
D) the discovery of fraudulent documents within a particular department.

Question 61

How is materiality determined?

Question 62

What is meant by behavioral red flags?

Question 63

Is earnings management considered fraud?

Question 64

What is the role of the external auditor in the financial reporting process?

Question 65

What are some red flags that may indicate that fraud is occurring?

Question 66

Generally, how is the problem of management override and collusion addressed?

Question 67

What are the primary responsibilities of management?

Question 68

What are the similarities and differences between analytical and accounting anomalies?

Question 69

A scientist has an unlimited water supply and two buckets; one holds four gallons and the other holds nine gallons. By using nothing but the buckets and water, how can she accurately measure seven gallons of water?

Question 70

What are the main components of the fraud risk assessment process?

Question 71

What is the "expectations gap"?