C254 Fraud and Forensic Accounting Practice Questions - Set 1 - Part 1

Correct Answer: They present a fair picture of the financial position and results of the organization.

Financial statements aim to provide a fair and accurate representation of a company's financial status. While they are not designed to market the company, they are critical for investors and stakeholders to make informed decisions. The other options either misunderstand the purpose or exaggerate the risks of fraud.

Correct Answer: They are prepared with integrity, and there is a system that checks all published statements.

Financial statements in the U.S. are trusted due to stringent regulations and integrity in the preparation process, enforced by regulatory bodies. The SEC and independent audits help maintain the trustworthiness, not technological superiority or the elimination of fraud.

Correct Answer: Sarbanes-Oxley Act (SOX)

SOX, passed in 2002, was a landmark law created to protect against corporate fraud and to increase transparency in financial reporting. It introduced the PCAOB to oversee auditors of public companies. Other acts listed focus on different issues, such as insider trading or foreign bribery.

Correct Answer: Symptoms, or red flags, cannot be ranked in order of their significance or extent.

No single fraud symptom can be ranked as the most significant. Different cases of fraud will have different telltale signs, and it’s critical to evaluate them collectively rather than focusing on a singular "most important" red flag. Other options present valid red flags but do not apply universally.

Correct Answer: All of the above.

Financial statement fraud is often driven by multiple motivations, including the desire to support stock prices, bond offerings, or present a healthier financial picture. Each of the options presented in this question represents a valid reason for committing fraud.

Correct Answer: The new auditor will not know what is "normal" for the client.

When companies switch auditors, the new auditor lacks the historical familiarity with the client, making it harder to identify irregularities or establish a baseline of normal behavior. The other answers either exaggerate or misrepresent the reasons for caution when switching auditors.

Correct Answer: To protect against financial fraud and increase corporate accountability.

SOX was introduced after several high-profile corporate fraud scandals, aiming to protect investors and increase transparency in financial reporting. Other options focus on different issues not directly addressed by SOX.

Correct Answer: Discrepancies between supporting documentation and financial records.

Discrepancies in records are a key indicator of potential fraud, particularly when financial statements and supporting documentation do not align. The other options may or may not be relevant, but they are not as directly tied to fraud detection.

Correct Answer: Financial statement fraud.

Financial statement fraud often involves overstating assets to make the company appear more financially stable or profitable than it actually is. This contrasts with liability or expense fraud, which may focus on understating debts or costs.

Correct Answer: PCAOB Standard No. 2

SAS No. 99 specifically requires auditors to hold brainstorming sessions to identify potential fraud risks, aiming to incorporate a more creative approach to fraud detection. SAS No. 82 and other standards focus on different areas of fraud detection and reporting.

Correct Answer: To oversee the auditors of public companies and enforce audit standards.

The PCAOB was created under SOX to ensure that public company auditors adhere to high standards of accountability, accuracy, and integrity. The PCAOB does not directly audit companies or regulate stock trading.

Correct Answer: False

Financial statement fraud is often committed by senior management, who have access to financial data and the ability to override controls. Lower-level employees may not have the necessary access or power to commit this type of fraud.

Correct Answer: Misstating revenues

Misstating revenues, such as recognizing them too early or creating fictitious sales, is the most common method used in financial statement fraud. Other methods, while significant, are less common.

Correct Answer: Identifying unusual relationships through analytical procedures

Analytical procedures, such as comparing financial ratios and identifying abnormal trends, are highly effective in detecting signs of fraud. Focusing on dollar amount changes or relying solely on management’s statements is less reliable.

Correct Answer: True

Revenue recognition rules are frequently violated in financial statement fraud, as improper timing or recording of revenue can significantly inflate a company’s financial position.

Correct Answer: All of the above

Financial statement fraud is often committed to meet financial targets, improve stock prices, or maintain credit ratings. Each of these motivations can push individuals to manipulate financial data.

Correct Answer: True

SAS No. 99 requires auditors to presume that there is a risk of material misstatement related to revenue unless proven otherwise, as revenue manipulation is so common.

Correct Answer: True

Fraud is usually concealed through various methods, making it challenging to identify. This is why fraud detection often requires analytical procedures, skepticism, and surprise elements during audits.

Correct Answer: To assess and report on the effectiveness of the company’s internal controls annually

Section 404 of SOX requires management to assess and report on the effectiveness of internal controls over financial reporting, helping to detect and prevent fraud within the organization.

Correct Answer: Questioning the validity of evidence and considering alternative explanations

Professional skepticism involves maintaining a questioning mindset and critically evaluating the evidence provided, rather than simply trusting management or assuming that all is accurate.