C254 Fraud and Forensic Accounting Practice Questions - Set 5 - Part 1

Correct Answer: They create false expectations about the company’s performance.

Fraudulent financial statements inflate the company’s performance, misleading investors and artificially increasing the company’s stock price. When fraud is discovered, the stock price typically plummets.

Correct Answer: False.

Financial statement fraud is usually committed by top management to benefit the organization, often to meet financial targets or maintain stock price.

Correct Answer: Cash flow manipulation fraud.

Cash flow manipulation fraud involves altering the cash flow statement to make the company appear more liquid or financially stable than it truly is.

Correct Answer: Large increases in sales without a corresponding increase in cash flow.

A sharp rise in sales without a corresponding increase in cash flow may indicate revenue recognition fraud, such as recording fictitious sales or prematurely recognizing revenue.

Correct Answer: Delaying the recognition of expenses.

Delaying expense recognition can inflate profits by reducing the expenses reported during the current period, making the company appear more profitable.

Correct Answer: True.

Fraudulent financial reporting can lead to legal penalties, financial losses, damaged reputations, and in some cases, imprisonment for those involved.

Correct Answer: Artificially inflating net income and equity.

Understating liabilities makes the company appear financially stronger by inflating net income and equity, which can mislead investors and creditors.

Correct Answer: To encourage auditors to assess fraud risks throughout the audit process.

SAS No. 99 emphasizes the need for auditors to continually assess fraud risks during the audit and adjust procedures accordingly.

Correct Answer: High employee turnover in accounting and finance departments.

High turnover in accounting and finance departments can be a red flag for fraud, as it may indicate poor internal controls or attempts to conceal fraudulent activities.

Correct Answer: Recording fictitious sales.

Fictitious sales involve creating false sales transactions to inflate revenue and make the company appear more profitable than it really is.

Correct Answer: False

While auditors play a crucial role in detecting fraud, management is responsible for implementing effective internal controls to prevent and detect fraud.

Correct Answer: Overstating ending inventory.

Overstating ending inventory reduces the reported cost of goods sold, which increases gross profit and inflates net income.

Correct Answer: An increase in purchases without a corresponding increase in accounts payable.

If purchases increase but accounts payable remains flat, it may indicate that liabilities are being understated, which is a red flag for fraud.

Correct Answer: To convert financial statement data into percentages for comparison purposes.

Vertical analysis transforms financial data into percentages of a base figure, which helps auditors detect any anomalies or trends that may indicate fraud.

Correct Answer: Expense understatement fraud.

Expense understatement fraud occurs when a company understates its expenses to inflate net income and improve its financial performance.

Correct Answer: True

Manipulating the allowance for doubtful accounts is a common method used in fraud to inflate net income by reducing the amount of bad debt expense recognized.

Correct Answer: A sharp decline in inventory turnover.

A significant drop in inventory turnover may suggest that inventory is being overstated or that fictitious inventory is being recorded, both of which are indicators of fraud.

Correct Answer: Rationalization of the fraudulent behavior.

Rationalization is one of the three components of the fraud triangle and involves the fraudster justifying their dishonest actions to themselves.

Correct Answer: An artificial boost in stock price.

Manipulating revenue inflates the company’s financial performance, leading to an artificial increase in stock price, which can result in significant losses when the fraud is discovered.

Correct Answer: It decreases cost of goods sold and inflates net income.

Overstating inventory reduces the cost of goods sold, which inflates net income and makes the company appear more profitable.