All Exams

Chapter 05 - Audit Responsibilities and Accounting Fraud
Chapter 05 Audit Responsibilities and Accounting Fraud

Multiple Choice Questions
1. Deliberately underbidding for an audit engagement to obtain a client and secure more lucrative management advisory or consulting services is known as: A. Opinion shopping B. High-balling C. Low-balling D. Client shopping
2. One of the articles of professional conduct, due care, requires a member to discharge professional responsibilities with _______ and _______. A. Confidentiality and integrity B. Objectivity and ethics C. Standard morals and ethics D. Competence and diligence
3. Susie is an auditor with XYZ Audit firm. The Senior Audit member has told her that all fieldwork must be completed by the end of the week. Susie knows that corners have been cut and certain tests not completed due to the time constraints. The integrity of the firm could be compromised. What should Susie do? A. Do nothing. B. Talk with the chain of command of the client to see that her concerns are dealt with. C. Follow the chain of command of XYZ to see that her concerns are dealt with. D. Talk with a reporter from the Wall Street Journal.
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4. The expectations gap refers to: A. The space that exists between a train coming into the station and the platform used to board the train B. The difference between what the public expects an audit to uncover and what the profession believes is the purpose of an audit C. The difference between projected earnings based on analysts' expectations and actual earnings D. The difference between what the audit sets out to discover and what it actually does discover
5. Which of the following is an element of the introductory paragraph of an auditor's report? A. Identifies the type of opinion the auditor is giving B. Identifies the management's responsibilities for the statements C. Identifies audit testing and procedures used D. Identifies the generally accepted auditing standards followed in conducting the audit
6. Which of the following is not an element of the scope paragraph of the auditor's report? A. States the auditor's responsibility to express an opinion on the financial statements. B. States the audit provides reasonable assurance that the statements are free of material misstatement. C. States audit provides reasonable basis for the opinion. D. States the audit evaluates the overall financial statement presentation.
7. Typically, when a going concern issue exists the auditor should: A. Issue an unqualified opinion with an explanatory paragraph B. Explain the reasons for the going concern issue C. Indicate where management's plans to deal with the going concern are addressed D. All of the above
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8. Which of the following is the most likely reason for an auditor to issue a qualified opinion? A. Inability to gather sufficient relevant information to form the basis for the opinion B. Differences with management that lead to trust issues on the part of the auditor C. Going concern issue D. Difference of opinion with management on the application of generally accepted accounting principles
9. Adverse opinions are preceded by a separate paragraph that should contain all of the following except for: A. Substantive alternative treatments of GAAP B. Substantive reasons for the adverse opinion C. Principal effect of the adverse treatment on financial position and results of operations and cash flows D. All of the above should be included in explaining the basis for the adverse opinion
10. Under which of the following set of circumstances might the auditors disclaim an opinion? A. The financial statements contain a departure from generally accepted accounting principles, the effect of which is material B. There is a client scope restriction that precludes the auditors' compliance with generally accepted auditing standards C. There has been a material change between periods in the method of the application of accounting principles D. Differences with management that lead to trust issues on the part of the auditor
11. When would it be appropriate for an auditor to withdraw from an engagement? A. In order to avoid issuing an adverse opinion. B. When that auditor cannot observe the taking of inventory or is unable to confirm receivables. C. When the management cannot be trusted. D. When the auditor has overbooked too much work.
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12. Which of the following is true about PCAOB audit standards? A. The required standards apply to all companies B. The required standards apply to all public companies only C. The required standards apply to all privately held companies only D. The required standards apply to all not-for-profit entities
13. Which of the following summarizes the essence of general standards of GAAS? A. Quality of professionals that perform an audit B. Criteria used to judge whether the audit has met quality requirements C. The standards that guide auditors in issuing the audit report D. Whether the auditor obtained sufficient competent evidential matter to render an opinion
14. Which of the following summarizes the essence of field work standards of GAAS? A. Quality of professionals that perform an audit B. Criteria for judging the quality of audit work C. Whether the auditor was independent in conducting the audit D. Whether the auditor reviewed the client's financial statements for adherence to GAAP
15. Which of the following is not one of the reporting standards of GAAS that guides auditors in formulating the audit opinion? A. The financial statements have followed GAAP. B. Consistency in the application of GAAP. C. Adequate disclosures exist in the statements. D. Gathering sufficient audit evidence to warrant an opinion.
16. Some critics claim the usefulness of the audit report is limited because: A. Auditors do not examine all of the transactions B. Language in the audit report relies on subjective evaluations such as what is meant by "reasonable" C. Transactions examined are based on materiality and risk assessment determinations D. All of the above may create doubts about usefulness
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17. Which of the following is not correct about materiality? A. The concept of materiality recognizes that some matters are more important for fair presentation of financial statements B. Materiality judgments are made in light of surrounding circumstances and necessarily involve quantitative and qualitative judgments C. Materiality should be predictable from audit to audit so that the readers of financial statements know what constitutes materiality D. An auditor's consideration of materiality is influenced by the auditor's perception of the need of the readers of the financial statements
18. The auditors' determination of whether the financial statements "present fairly" is based on: A. Whether the users are able to assess the reliability of the financial statements B. Whether the statements have been prepared in accordance with the same GAAP used from one year to another C. Whether the auditor has been able to gather sufficient evidence to warrant the statement that the financial statements present fairly D. Whether the accounting principles used are appropriate in the circumstances
19. Which of the following is not a component of internal control? A. Control environment B. Information and communication systems C. Monitoring of controls D. Independence of the audit committee
20. The auditor's responsibility with regard to illegal acts is greatest when: A. The illegal acts have an indirect and material effect on financial statement amounts B. The illegal acts have a direct and material effect on financial statement amounts C. The illegal acts have a direct and immaterial effect on financial statement amounts D. Illegal acts exist regardless of the effects on the financial statements
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21. The first step for an auditor who concludes an illegal act exists is to: A. Bring the matter to the attention of the audit committee B. Bring the matter to the attention of the SEC C. Assess the impact of the illegal act on the financial statements D. Assess the impact of the illegal act on the auditor's opinion
22. An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the A. Auditor is precluded from obtaining sufficient competent evidence about the illegal act B. Illegal act has an effect on the financial statements that is both material and direct C. Auditor cannot reasonably estimate the effect of the illegal act on the financial statements D. Client refuses to take the remedial steps deemed necessary by the auditors
23. The Private Securities Litigation Reform Act imposes additional requirements on public companies reporting to the SEC and their auditors when: A. The illegal act has a material effect on the financial statements B. Senior management and the board have not acted properly to correct for the act C. The failure to correct for the action is reasonably expected to warrant a departure from the standard audit report D. All of the above are additional requirements
24. Auditors are responsible to detect and correct errors when they are: A. Material B. Material or immaterial C. Due to an illegal act D. Management fails to correct for the error
25. The auditors' responsibility to communicate findings with respect to fraud can best be summarized as: A. Communicate to the audit committee both material and immaterial amounts of fraud B. Communicate to the audit committee both material and immaterial amounts of fraud that are detected C. Communicate to the SEC material amounts of fraud D. Communicate to the SEC both material and immaterial amounts of fraud that are detected
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26. The purpose of the fraud triangle is to identify: A. The causes of when the audit opinion should be qualified. B. To identify the causes of when there may be intentional misstatements or omissions of amounts or disclosures in the financial statements. C. To identify the causes of when there is a lack of independence in performing an audit. D. All of the above.
27. Which of the following is not part of the fraud triangle? A. Incentives B. Opportunity C. Materiality D. Rationalization
28. The difference between an error in the financial statements as compared to fraud is: A. An error is always an intentional act designed to deceive another party B. Fraud is always an intentional act designed to deceive another party C. An error always leads to a qualification of the auditors' opinion D. Fraudulent financial reporting is always material in amount
29. Each of the following represents a pressure that might lead to fraud except for: A. Desire to maximize the value of stock options B. Budget pressures C. Meet financial analysts' earnings expectations D. Inadequate internal controls
30. All of the following are in a position to commit fraud except for: A. Employees who have access to assets B. Top management who can override internal controls C. External auditors who manipulate the amounts recorded in the financial statements D. All of the above are in a position to commit fraud
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31. All of the following tend to be rationalizations for fraud except for: A. We need to protect the shareholders and keep the stock price high. B. All companies use aggressive accounting techniques. C. The employee will be fired unless s/he goes along with the fraud. D. We are correcting a temporary problem that will not exist in the future.
32. The misappropriation of assets refers to: A. The deliberate use of company assets for personal reasons. B. The deliberate overstatement of financial statements. C. The deliberate omission of disclosures from the statements. D. All of the above.
33. Backdating options refers to: A. Crossing out the date of exercise on the option certificate and changing it to an earlier date when the stock price was lower B. Changing the grant date of the options to lower the exercise price and reduce reported earnings C. Granting options to employees working for the company in years prior to the granting of the options D. Changing the future exercise price to correspond market increases in the stock price
34. The fraud at Tyco included each of the following acts except for: A. Benefits given to certain members of the board of directors to secure their silence about the fraud B. Corporate assets used by members of top management for personal purposes C. Setting up special-purpose-entities to keep debt off Tyco's books D. Related party transactions that were not adequately disclosed
35. Members of the audit committee are responsible for each of the following except for: A. Evaluating management's identification of fraud risks B. Assessing whether management has set the appropriate ethical tone for the organization C. Discussing with the external auditors financial reporting matters of concern D. Rendering an audit opinion after examining the entity's financial statements and internal controls
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36. What is the motive behind the PCAOB Integrated Audit Concept? A. Elevation of importance of internal controls B. Improvement of the quality and integrity of both internal controls over financial reporting and independent financial statement audits C. Improvement of the speed and reliability of both corporate financial reporting and independent financial statement audits D. Elevation of importance of independent financial statement audits
37. The AICPA issued eight Statements on Auditing Standards (SAS 104-111) that address risk assessment with respect to: A. The design and performance of audit procedures to respond to assessed risks B. Whether the standards close the expectation gap C. The role and responsibilities of the audit committee in preventing fraud D. All of the above
38. The eight risk assessment auditing standards issued by the AICPA identify the following types of misstatements: A. Known and unknown misstatements B. Likely and unknown misstatements C. Known and likely misstatements D. All material misstatements
39. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1987-1997 periods when business failures due to accounting fraud were high and found that: A. Top management was frequently involved in the fraud with the CEO being the person most frequently involved B. Top management was frequently involved in the fraud with the CFO being the person most frequently involved C. The audit committee always sanctioned the fraud D. A minority of audit reports issued during the fraud period contained unqualified audit opinions
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40. PCAOB Auditing Standard No.4 requires that the external auditors should take each of the following steps when reporting on whether a material weakness still exists in the internal controls except for: A. Evaluate whether management has accepted responsibility for the effectiveness of internal control B. Evaluate whether management asserts whether the controls are effective in correcting the material weakness C. Evaluate whether management has obtained sufficient evidence to support its assessment D. Evaluate whether management has conducted an audit of internal controls
41. A study conducted of financial statement restatements in 2007 and 2008 indicated a decline in the number of restatements as a result of each of the following except for: A. Improved audits of financial statements B. Improved reliability of internal controls C. A more relaxed approach of the SEC regarding materiality and the need to file restatements D. All were cited as reasons for the decline
42. One ethical dilemma for professional accountants is a conflict between the interests of the stakeholders. Who or what is a stakeholder? A. Everyone but the people within the company B. People who are affected by the outcomes of decisions that are made C. Supervisor of an accountant D. Employees only
43. Which of the following statements is correct regarding auditor independence as stated by the AICPA in Rule 101? A. A covered member's immediate family can have a direct financial interest in a client. B. A covered member can have a joint investment with a client. C. A covered member involved in the audit of a bank can have an auto loan at the bank. D. A covered member can have a direct financial interest in a client as long as it is not material and is disclosed properly.
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44. If a company is seeking out views of different accounting firms until they find one with a desired accounting treatment, it would be called ______. A. Low-balling. B. Under bidding. C. Opinion shopping. D. Option pricing.
45. Which is not a link of the chain of command that the controller should inform of a material misstatement in the financial statements? A. Audit Committee of Board of Directors B. CEO C. Hotline D. CFO
46. Which of the following is considered a negative auditor's opinion? A. Standard opinion B. Qualified opinion C. Unqualified opinion D. Adverse opinion
47. Which of the following is a reason for an auditor to issue a qualified opinion? A. Difference of opinion with management on presentation of financial statements in the annual report B. Difference of opinion with management on earnings estimate of a material amount C. Difference of opinion with management on preferred accounting principles under GAAP D. Difference of opinion with management on a material application of accounting standards
48. Which of the following is an example of opinion shopping by a company? A. Changing auditors due to the quality of work by the auditors B. Changing auditors due to wanting desired accounting treatment C. Changing auditors due to the size of the audit fees D. Changing auditors due to the size of the audit firm
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49. In which of the following circumstances would an adverse opinion be appropriate? A. An uncertainty prevents the issuance of a standard unqualified opinion. B. The statements are not in conformity with generally accepted accounting principles regarding stock options plans. C. The auditor has been unable to obtain sufficient competent evidential matter. D. The principal auditors decide to make reference to the report of another auditor who audited a subsidiary.
50. Which of the following is not true of "reasonable assurance"? A. Exercise of due care B. Absolute guarantee C. Appearance of independence D. Followed GAAS
51. Which of the following is not a consideration in determining a measure of materiality? A. Strong internal control B. Five percent of net income C. Risks of material misstatements due to fraud D. Risks of illegal acts
52. What is the auditor's responsibility with regard to illegal acts? A. To detect and report illegal acts that have an indirect and material effect on financial statement amounts. B. To detect and report illegal acts that have a direct and material effect on financial statement amounts. C. To detect and report illegal acts that have a direct and immaterial effect on financial statement amounts. D. To detect and report illegal acts that have an indirect and immaterial effect on financial statement amounts.
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53. Which of the following is not an area of fraud considerations detailed by SAS 99? A. Assessing the impact of fraud B. Professional skepticism about fraud C. Identifying risks of fraud D. Characteristics of fraud
54. PCAOB Auditing Standard No. 2 and eight risk assessment standards of AICPA require the auditor to do all but: A. A more in-depth understanding of the entity and environment. B. A rigorous assessment of risk of material misstatement. C. Linkage between the risks of misstatement and the nature, timing, and extent of audit procedures. D. A more-in-depth sampling of evidence.
55. Because of the risk of material misstatement, an audit of financial statements in accordance with GAAS should be planned and performed with an attitude of A. Objective judgment B. Professional skepticism C. Independent integrity D. Impartial conservatism
56. The framework of COSO Enterprise Risk Management is to A. Incorporate enhanced internal control principles into enhanced corporate governance. B. Incorporate enhanced audit sampling procedures in the testing of internal controls. C. Incorporate enhanced corporate governance into internal control principles. D. Incorporate enhanced audit sampling procedures in substantive testing.
57. Which of the following is not an element of COSO Enterprise Risk Management? A. Enhancing risk response decisions B. Reducing operating surprises and losses C. Seizing opportunities D. Improving deployment of information technology
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58. Management's attitude toward aggressive financial statement reporting and its emphasis on meeting projected profit numbers would significantly influence an entity's control environment when A. Internal auditors report to the audit committee B. The audit committee is active in overseeing the entity's financial reporting C. Management is dominated by one shareholder with little other governance D. Management does not have a stock option plan
59. In the General Electric case, each of the following allegations were made against the company except for the following: A. Offered to sell company securities during the period when the company issued materially misleading financial statements B. Obtained money or property by the use of untrue statements of material facts or omission of material information C. Misuse of company resources by members of top management D. Failure to maintain an internal control system sufficient to provide reasonable assurance that the financial statements were prepared in conformity with GAAP
60. Issues related to a peer review of an audit are the subject matter of which case? A. Kazweski & Dooktaviski B. Imperial Valley Thrift & Loan C. Audit Client Considerations D. Marcus Yamabuto
61. In the Imperial Valley Thrift & Loan case, each of the following were reasons for the going concern issue except for: A. The magnitude of loan losses B. Insufficient equity capital C. Operating losses over an extended period of time D. Questions about the collectability of outstanding loans
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62. The primary issue discussed in the Krispy Kreme case was: A. Use of special-purpose-entities to keep debt off the books B. Use of "round trip" transactions to accelerate the recording of earnings C. Internal controls over operating activities D. Internal controls over the making of doughnuts
63. The Audit Client Consideration case deals with issues related to: A. Acceptance of new clients B. Issues that arise between the predecessor audit firm and the client C. Going concern issues raised by previous auditors D. All of the above
64. The Marcus Yamabuto case deals with issues related to: A. Premature revenue recognition B. Franchise revenue accounting C. Special purpose entities D. All of the above
65. The audit report on Sky Hook, Inc. that was discussed in The Audit Report case contained each of the following deficiencies except for: A. The report was not addressed to the shareholders and/or the board of directors B. The report failed to identify the comparative financial statements included in the audit C. The failure to properly identify the auditing standards followed D. The failure to render an opinion based on the audit
66. An unusual aspect of the Edvid case is that the company: A. Accelerated the recording of revenue into an earlier period than seemed to be justified B. Delayed the of recognition of revenue into a later period than seemed justified C. The falsification of inventory amounts D. All of the above
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67. Fannie Mae's financial statements were investigated because of allegations that the company: A. Deferred derivative losses on the balance sheet thereby inflating profits B. Used derivatives to hide subprime loans C. Sold derivatives to increase cash flows prior to bank financing D. All of the above
68. The primary accounting issue in the Royal Ahold case is: A. Fraudulent recording of revenues on sales to customers B. Fraudulent use of company resources by top management for personal purposes C. Fraudulent inflation of promotional allowances to increase operating income D. Fraudulent inflation of inventory to reduce losses on the income statement
Essay Questions
69. Explain each of the three sides of the fraud triangle (SAS 99) with respect to how it contributes toward the possibility that fraud in the financial statements may be present.
70. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1987-1997 periods when business failures due to accounting fraud were high. Describe the major findings of COSO with respect to financial statement fraud.
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71. Explain the circumstances under which an auditor should give each of the following opinions: (a) Unqualified opinion (b) Unqualified opinion with an explanatory paragraph (c) Qualified opinion (d) Adverse opinion
72. Materiality is one of the most difficult judgments to make in auditing financial statements. Explain what is meant by materiality and explain the basis for the auditor's assessment of whether there is a material misstatement in the financial statements.
73. Differentiate between the auditors' responsibilities to detect errors, fraud, and illegal acts. How would you assess the ethics of a company that has experienced each event with respect to motivation and the integrity of those who go along with such events?
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74. In the Tyco fraud the corporate governance system completely broke down. Explain the failings in the corporate governance system at Tyco and how the Sarbanes-Oxley Act addresses those failings.
75. Explain the auditors' responsibilities to assess fraud including the role of professional judgment.
76. What are the audit committee's responsibilities with respect to fraud and risk assessment?
77. Kohlberg's model addresses the stages of moral development a person might move through in developing a strong sense of ethics. Analyze each of those stages with respect to the three elements of the fraud triangle. How can an individual resist the temptation to become involved in fraud by possessing the characteristics of behavior included in each stage?
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78. Describe the steps that auditors should take under Auditing Standard No. 4 of the PCAOB to report on whether a previously reported material weakness still exists.
79. Mr. Arty works for Smile Accounting Firm as a senior accountant. Currently he is doing review of rental property compliance testing completed by the staff accountants. He realizes that the staff accountants only tested two tenants per property instead of the required three by the audit program. To request more information from the client would cause massive delays and the manager is pressing hard for the information before the Christmas vacation. What should Mr. Arty do and why? Use the ethical theory and ethical decision making model to discuss the situation.
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80. Campus Fast is a new audit client. Client Fast uses public Wi-Fi to place and deliver restaurant take out for students at the Up and Coming State University. Campus Fast was founded by three highly ambitious MBA students at the university. The business plan is to find a buyer or place an IPO of the company by graduation in two years. The founders expect to pay off all student loans, take a tour around the world and then start another company. In order for the business plan to work on the timeline for graduation, the business must meet highly ambitious earnings numbers. Additionally, the company is dealing with two situations that the founders would like to keep from the auditors: 1) The company has been using free, unsecured public Wi-Fi to take orders via the Internet. The customer may pay via the Internet. Several students, who all happen to be members of the same student organization on campus, are claiming that using Campus Fast has allowed their identity to be stolen. One student is claiming that she had $12,000 of charges on her credit card to the unsecured Internet site of Campus Fast. Management plans to pay off the complaining students and keep the true liability off the balance sheet. "An interest buyer has about the unsecured site and might get scared by the student complaints". 2) The company guarantees fast delivery. It has offered to pay any speeding or other moving violation tickets to its delivery drivers. Unfortunately one of the drivers was involved in an accident due to running a red light. The passenger in the other car is in critical condition and the intensive care unit in the hospital. The driver has promised the family of the passenger that the company will make good on any expenses and admitted the company policy on repaying all traffic tickets. Attorneys for the injured party are threatening to sue and publicize the situation. The founders do not have enough cash to take care of this problem but are still trying to keep the situation from the auditors and potential buyer. Using the internal control framework from SAS 55, 98, COSO and Enterprise Risk Management, assess the internal control and risks of Campus Fast.
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Chapter 05 Audit Responsibilities and Accounting Fraud Answer Key
1. Deliberately underbidding for an audit engagement to obtain a client and secure more lucrative management advisory or consulting services is known as: A. Opinion shopping B. High-balling C. Low-balling D. Client shopping
2. One of the articles of professional conduct, due care, requires a member to discharge professional responsibilities with _______ and _______. A. Confidentiality and integrity B. Objectivity and ethics C. Standard morals and ethics D. Competence and diligence
3. Susie is an auditor with XYZ Audit firm. The Senior Audit member has told her that all fieldwork must be completed by the end of the week. Susie knows that corners have been cut and certain tests not completed due to the time constraints. The integrity of the firm could be compromised. What should Susie do? A. Do nothing. B. Talk with the chain of command of the client to see that her concerns are dealt with. C. Follow the chain of command of XYZ to see that her concerns are dealt with. D. Talk with a reporter from the Wall Street Journal.
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4. The expectations gap refers to: A. The space that exists between a train coming into the station and the platform used to board the train B. The difference between what the public expects an audit to uncover and what the profession believes is the purpose of an audit C. The difference between projected earnings based on analysts' expectations and actual earnings D. The difference between what the audit sets out to discover and what it actually does discover
5. Which of the following is an element of the introductory paragraph of an auditor's report? A. Identifies the type of opinion the auditor is giving B. Identifies the management's responsibilities for the statements C. Identifies audit testing and procedures used D. Identifies the generally accepted auditing standards followed in conducting the audit
6. Which of the following is not an element of the scope paragraph of the auditor's report? A. States the auditor's responsibility to express an opinion on the financial statements. B. States the audit provides reasonable assurance that the statements are free of material misstatement. C. States audit provides reasonable basis for the opinion. D. States the audit evaluates the overall financial statement presentation.
7. Typically, when a going concern issue exists the auditor should: A. Issue an unqualified opinion with an explanatory paragraph B. Explain the reasons for the going concern issue C. Indicate where management's plans to deal with the going concern are addressed D. All of the above
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8. Which of the following is the most likely reason for an auditor to issue a qualified opinion? A. Inability to gather sufficient relevant information to form the basis for the opinion B. Differences with management that lead to trust issues on the part of the auditor C. Going concern issue D. Difference of opinion with management on the application of generally accepted accounting principles
9. Adverse opinions are preceded by a separate paragraph that should contain all of the following except for: A. Substantive alternative treatments of GAAP B. Substantive reasons for the adverse opinion C. Principal effect of the adverse treatment on financial position and results of operations and cash flows D. All of the above should be included in explaining the basis for the adverse opinion
10. Under which of the following set of circumstances might the auditors disclaim an opinion? A. The financial statements contain a departure from generally accepted accounting principles, the effect of which is material B. There is a client scope restriction that precludes the auditors' compliance with generally accepted auditing standards C. There has been a material change between periods in the method of the application of accounting principles D. Differences with management that lead to trust issues on the part of the auditor
11. When would it be appropriate for an auditor to withdraw from an engagement? A. In order to avoid issuing an adverse opinion. B. When that auditor cannot observe the taking of inventory or is unable to confirm receivables. C. When the management cannot be trusted. D. When the auditor has overbooked too much work.
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12. Which of the following is true about PCAOB audit standards? A. The required standards apply to all companies B. The required standards apply to all public companies only C. The required standards apply to all privately held companies only D. The required standards apply to all not-for-profit entities
13. Which of the following summarizes the essence of general standards of GAAS? A. Quality of professionals that perform an audit B. Criteria used to judge whether the audit has met quality requirements C. The standards that guide auditors in issuing the audit report D. Whether the auditor obtained sufficient competent evidential matter to render an opinion
14. Which of the following summarizes the essence of field work standards of GAAS? A. Quality of professionals that perform an audit B. Criteria for judging the quality of audit work C. Whether the auditor was independent in conducting the audit D. Whether the auditor reviewed the client's financial statements for adherence to GAAP
15. Which of the following is not one of the reporting standards of GAAS that guides auditors in formulating the audit opinion? A. The financial statements have followed GAAP. B. Consistency in the application of GAAP. C. Adequate disclosures exist in the statements. D. Gathering sufficient audit evidence to warrant an opinion.
16. Some critics claim the usefulness of the audit report is limited because: A. Auditors do not examine all of the transactions B. Language in the audit report relies on subjective evaluations such as what is meant by "reasonable" C. Transactions examined are based on materiality and risk assessment determinations D. All of the above may create doubts about usefulness
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17. Which of the following is not correct about materiality? A. The concept of materiality recognizes that some matters are more important for fair presentation of financial statements B. Materiality judgments are made in light of surrounding circumstances and necessarily involve quantitative and qualitative judgments C. Materiality should be predictable from audit to audit so that the readers of financial statements know what constitutes materiality D. An auditor's consideration of materiality is influenced by the auditor's perception of the need of the readers of the financial statements
18. The auditors' determination of whether the financial statements "present fairly" is based on: A. Whether the users are able to assess the reliability of the financial statements B. Whether the statements have been prepared in accordance with the same GAAP used from one year to another C. Whether the auditor has been able to gather sufficient evidence to warrant the statement that the financial statements present fairly D. Whether the accounting principles used are appropriate in the circumstances
19. Which of the following is not a component of internal control? A. Control environment B. Information and communication systems C. Monitoring of controls D. Independence of the audit committee
20. The auditor's responsibility with regard to illegal acts is greatest when: A. The illegal acts have an indirect and material effect on financial statement amounts B. The illegal acts have a direct and material effect on financial statement amounts C. The illegal acts have a direct and immaterial effect on financial statement amounts D. Illegal acts exist regardless of the effects on the financial statements
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21. The first step for an auditor who concludes an illegal act exists is to: A. Bring the matter to the attention of the audit committee B. Bring the matter to the attention of the SEC C. Assess the impact of the illegal act on the financial statements D. Assess the impact of the illegal act on the auditor's opinion
22. An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the A. Auditor is precluded from obtaining sufficient competent evidence about the illegal act B. Illegal act has an effect on the financial statements that is both material and direct C. Auditor cannot reasonably estimate the effect of the illegal act on the financial statements D. Client refuses to take the remedial steps deemed necessary by the auditors
23. The Private Securities Litigation Reform Act imposes additional requirements on public companies reporting to the SEC and their auditors when: A. The illegal act has a material effect on the financial statements B. Senior management and the board have not acted properly to correct for the act C. The failure to correct for the action is reasonably expected to warrant a departure from the standard audit report D. All of the above are additional requirements
24. Auditors are responsible to detect and correct errors when they are: A. Material B. Material or immaterial C. Due to an illegal act D. Management fails to correct for the error
25. The auditors' responsibility to communicate findings with respect to fraud can best be summarized as: A. Communicate to the audit committee both material and immaterial amounts of fraud B. Communicate to the audit committee both material and immaterial amounts of fraud that are detected C. Communicate to the SEC material amounts of fraud D. Communicate to the SEC both material and immaterial amounts of fraud that are detected
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26. The purpose of the fraud triangle is to identify: A. The causes of when the audit opinion should be qualified. B. To identify the causes of when there may be intentional misstatements or omissions of amounts or disclosures in the financial statements. C. To identify the causes of when there is a lack of independence in performing an audit. D. All of the above.
27. Which of the following is not part of the fraud triangle? A. Incentives B. Opportunity C. Materiality D. Rationalization
28. The difference between an error in the financial statements as compared to fraud is: A. An error is always an intentional act designed to deceive another party B. Fraud is always an intentional act designed to deceive another party C. An error always leads to a qualification of the auditors' opinion D. Fraudulent financial reporting is always material in amount
29. Each of the following represents a pressure that might lead to fraud except for: A. Desire to maximize the value of stock options B. Budget pressures C. Meet financial analysts' earnings expectations D. Inadequate internal controls
30. All of the following are in a position to commit fraud except for: A. Employees who have access to assets B. Top management who can override internal controls C. External auditors who manipulate the amounts recorded in the financial statements D. All of the above are in a position to commit fraud
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31. All of the following tend to be rationalizations for fraud except for: A. We need to protect the shareholders and keep the stock price high. B. All companies use aggressive accounting techniques. C. The employee will be fired unless s/he goes along with the fraud. D. We are correcting a temporary problem that will not exist in the future.
32. The misappropriation of assets refers to: A. The deliberate use of company assets for personal reasons. B. The deliberate overstatement of financial statements. C. The deliberate omission of disclosures from the statements. D. All of the above.
33. Backdating options refers to: A. Crossing out the date of exercise on the option certificate and changing it to an earlier date when the stock price was lower B. Changing the grant date of the options to lower the exercise price and reduce reported earnings C. Granting options to employees working for the company in years prior to the granting of the options D. Changing the future exercise price to correspond market increases in the stock price
34. The fraud at Tyco included each of the following acts except for: A. Benefits given to certain members of the board of directors to secure their silence about the fraud B. Corporate assets used by members of top management for personal purposes C. Setting up special-purpose-entities to keep debt off Tyco's books D. Related party transactions that were not adequately disclosed
35. Members of the audit committee are responsible for each of the following except for: A. Evaluating management's identification of fraud risks B. Assessing whether management has set the appropriate ethical tone for the organization C. Discussing with the external auditors financial reporting matters of concern D. Rendering an audit opinion after examining the entity's financial statements and internal controls
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36. What is the motive behind the PCAOB Integrated Audit Concept? A. Elevation of importance of internal controls B. Improvement of the quality and integrity of both internal controls over financial reporting and independent financial statement audits C. Improvement of the speed and reliability of both corporate financial reporting and independent financial statement audits D. Elevation of importance of independent financial statement audits
37. The AICPA issued eight Statements on Auditing Standards (SAS 104-111) that address risk assessment with respect to: A. The design and performance of audit procedures to respond to assessed risks B. Whether the standards close the expectation gap C. The role and responsibilities of the audit committee in preventing fraud D. All of the above
38. The eight risk assessment auditing standards issued by the AICPA identify the following types of misstatements: A. Known and unknown misstatements B. Likely and unknown misstatements C. Known and likely misstatements D. All material misstatements
39. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1987-1997 periods when business failures due to accounting fraud were high and found that: A. Top management was frequently involved in the fraud with the CEO being the person most frequently involved B. Top management was frequently involved in the fraud with the CFO being the person most frequently involved C. The audit committee always sanctioned the fraud D. A minority of audit reports issued during the fraud period contained unqualified audit opinions
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40. PCAOB Auditing Standard No.4 requires that the external auditors should take each of the following steps when reporting on whether a material weakness still exists in the internal controls except for: A. Evaluate whether management has accepted responsibility for the effectiveness of internal control B. Evaluate whether management asserts whether the controls are effective in correcting the material weakness C. Evaluate whether management has obtained sufficient evidence to support its assessment D. Evaluate whether management has conducted an audit of internal controls
41. A study conducted of financial statement restatements in 2007 and 2008 indicated a decline in the number of restatements as a result of each of the following except for: A. Improved audits of financial statements B. Improved reliability of internal controls C. A more relaxed approach of the SEC regarding materiality and the need to file restatements D. All were cited as reasons for the decline
42. One ethical dilemma for professional accountants is a conflict between the interests of the stakeholders. Who or what is a stakeholder? A. Everyone but the people within the company B. People who are affected by the outcomes of decisions that are made C. Supervisor of an accountant D. Employees only
43. Which of the following statements is correct regarding auditor independence as stated by the AICPA in Rule 101? A. A covered member's immediate family can have a direct financial interest in a client. B. A covered member can have a joint investment with a client. C. A covered member involved in the audit of a bank can have an auto loan at the bank. D. A covered member can have a direct financial interest in a client as long as it is not material and is disclosed properly.
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44. If a company is seeking out views of different accounting firms until they find one with a desired accounting treatment, it would be called ______. A. Low-balling. B. Under bidding. C. Opinion shopping. D. Option pricing.
45. Which is not a link of the chain of command that the controller should inform of a material misstatement in the financial statements? A. Audit Committee of Board of Directors B. CEO C. Hotline D. CFO
46. Which of the following is considered a negative auditor's opinion? A. Standard opinion B. Qualified opinion C. Unqualified opinion D. Adverse opinion
47. Which of the following is a reason for an auditor to issue a qualified opinion? A. Difference of opinion with management on presentation of financial statements in the annual report B. Difference of opinion with management on earnings estimate of a material amount C. Difference of opinion with management on preferred accounting principles under GAAP D. Difference of opinion with management on a material application of accounting standards
48. Which of the following is an example of opinion shopping by a company? A. Changing auditors due to the quality of work by the auditors B. Changing auditors due to wanting desired accounting treatment C. Changing auditors due to the size of the audit fees D. Changing auditors due to the size of the audit firm
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49. In which of the following circumstances would an adverse opinion be appropriate? A. An uncertainty prevents the issuance of a standard unqualified opinion. B. The statements are not in conformity with generally accepted accounting principles regarding stock options plans. C. The auditor has been unable to obtain sufficient competent evidential matter. D. The principal auditors decide to make reference to the report of another auditor who audited a subsidiary.
50. Which of the following is not true of "reasonable assurance"? A. Exercise of due care B. Absolute guarantee C. Appearance of independence D. Followed GAAS
51. Which of the following is not a consideration in determining a measure of materiality? A. Strong internal control B. Five percent of net income C. Risks of material misstatements due to fraud D. Risks of illegal acts
52. What is the auditor's responsibility with regard to illegal acts? A. To detect and report illegal acts that have an indirect and material effect on financial statement amounts. B. To detect and report illegal acts that have a direct and material effect on financial statement amounts. C. To detect and report illegal acts that have a direct and immaterial effect on financial statement amounts. D. To detect and report illegal acts that have an indirect and immaterial effect on financial statement amounts.
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53. Which of the following is not an area of fraud considerations detailed by SAS 99? A. Assessing the impact of fraud B. Professional skepticism about fraud C. Identifying risks of fraud D. Characteristics of fraud
54. PCAOB Auditing Standard No. 2 and eight risk assessment standards of AICPA require the auditor to do all but: A. A more in-depth understanding of the entity and environment. B. A rigorous assessment of risk of material misstatement. C. Linkage between the risks of misstatement and the nature, timing, and extent of audit procedures. D. A more-in-depth sampling of evidence.
55. Because of the risk of material misstatement, an audit of financial statements in accordance with GAAS should be planned and performed with an attitude of A. Objective judgment B. Professional skepticism C. Independent integrity D. Impartial conservatism
56. The framework of COSO Enterprise Risk Management is to A. Incorporate enhanced internal control principles into enhanced corporate governance. B. Incorporate enhanced audit sampling procedures in the testing of internal controls. C. Incorporate enhanced corporate governance into internal control principles. D. Incorporate enhanced audit sampling procedures in substantive testing.
57. Which of the following is not an element of COSO Enterprise Risk Management? A. Enhancing risk response decisions B. Reducing operating surprises and losses C. Seizing opportunities D. Improving deployment of information technology
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58. Management's attitude toward aggressive financial statement reporting and its emphasis on meeting projected profit numbers would significantly influence an entity's control environment when A. Internal auditors report to the audit committee B. The audit committee is active in overseeing the entity's financial reporting C. Management is dominated by one shareholder with little other governance D. Management does not have a stock option plan
59. In the General Electric case, each of the following allegations were made against the company except for the following: A. Offered to sell company securities during the period when the company issued materially misleading financial statements B. Obtained money or property by the use of untrue statements of material facts or omission of material information C. Misuse of company resources by members of top management D. Failure to maintain an internal control system sufficient to provide reasonable assurance that the financial statements were prepared in conformity with GAAP
60. Issues related to a peer review of an audit are the subject matter of which case? A. Kazweski & Dooktaviski B. Imperial Valley Thrift & Loan C. Audit Client Considerations D. Marcus Yamabuto
61. In the Imperial Valley Thrift & Loan case, each of the following were reasons for the going concern issue except for: A. The magnitude of loan losses B. Insufficient equity capital C. Operating losses over an extended period of time D. Questions about the collectability of outstanding loans
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62. The primary issue discussed in the Krispy Kreme case was: A. Use of special-purpose-entities to keep debt off the books B. Use of "round trip" transactions to accelerate the recording of earnings C. Internal controls over operating activities D. Internal controls over the making of doughnuts
63. The Audit Client Consideration case deals with issues related to: A. Acceptance of new clients B. Issues that arise between the predecessor audit firm and the client C. Going concern issues raised by previous auditors D. All of the above
64. The Marcus Yamabuto case deals with issues related to: A. Premature revenue recognition B. Franchise revenue accounting C. Special purpose entities D. All of the above
65. The audit report on Sky Hook, Inc. that was discussed in The Audit Report case contained each of the following deficiencies except for: A. The report was not addressed to the shareholders and/or the board of directors B. The report failed to identify the comparative financial statements included in the audit C. The failure to properly identify the auditing standards followed D. The failure to render an opinion based on the audit
66. An unusual aspect of the Edvid case is that the company: A. Accelerated the recording of revenue into an earlier period than seemed to be justified B. Delayed the of recognition of revenue into a later period than seemed justified C. The falsification of inventory amounts D. All of the above
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67. Fannie Mae's financial statements were investigated because of allegations that the company: A. Deferred derivative losses on the balance sheet thereby inflating profits B. Used derivatives to hide subprime loans C. Sold derivatives to increase cash flows prior to bank financing D. All of the above
68. The primary accounting issue in the Royal Ahold case is: A. Fraudulent recording of revenues on sales to customers B. Fraudulent use of company resources by top management for personal purposes C. Fraudulent inflation of promotional allowances to increase operating income D. Fraudulent inflation of inventory to reduce losses on the income statement
Essay Questions
69. Explain each of the three sides of the fraud triangle (SAS 99) with respect to how it contributes toward the possibility that fraud in the financial statements may be present. Answers will vary
70. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1987-1997 periods when business failures due to accounting fraud were high. Describe the major findings of COSO with respect to financial statement fraud. Answers will vary
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71. Explain the circumstances under which an auditor should give each of the following opinions: (a) Unqualified opinion (b) Unqualified opinion with an explanatory paragraph (c) Qualified opinion (d) Adverse opinion Answers will vary
72. Materiality is one of the most difficult judgments to make in auditing financial statements. Explain what is meant by materiality and explain the basis for the auditor's assessment of whether there is a material misstatement in the financial statements. Answers will vary
73. Differentiate between the auditors' responsibilities to detect errors, fraud, and illegal acts. How would you assess the ethics of a company that has experienced each event with respect to motivation and the integrity of those who go along with such events? Answers will vary
74. In the Tyco fraud the corporate governance system completely broke down. Explain the failings in the corporate governance system at Tyco and how the Sarbanes-Oxley Act addresses those failings. Answers will vary
75. Explain the auditors' responsibilities to assess fraud including the role of professional judgment. Answers will vary
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76. What are the audit committee's responsibilities with respect to fraud and risk assessment? Answers will vary
77. Kohlberg's model addresses the stages of moral development a person might move through in developing a strong sense of ethics. Analyze each of those stages with respect to the three elements of the fraud triangle. How can an individual resist the temptation to become involved in fraud by possessing the characteristics of behavior included in each stage? Answer will vary
78. Describe the steps that auditors should take under Auditing Standard No. 4 of the PCAOB to report on whether a previously reported material weakness still exists. Answer will vary
79. Mr. Arty works for Smile Accounting Firm as a senior accountant. Currently he is doing review of rental property compliance testing completed by the staff accountants. He realizes that the staff accountants only tested two tenants per property instead of the required three by the audit program. To request more information from the client would cause massive delays and the manager is pressing hard for the information before the Christmas vacation. What should Mr. Arty do and why? Use the ethical theory and ethical decision making model to discuss the situation. This situation is a violation of due care general auditing standard and possibly sufficient evidential matter field work standard, both of which could affect the opinion. From rights, deontology and utilitarian approach, the auditor should do the required work.
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80. Campus Fast is a new audit client. Client Fast uses public Wi-Fi to place and deliver restaurant take out for students at the Up and Coming State University. Campus Fast was founded by three highly ambitious MBA students at the university. The business plan is to find a buyer or place an IPO of the company by graduation in two years. The founders expect to pay off all student loans, take a tour around the world and then start another company. In order for the business plan to work on the timeline for graduation, the business must meet highly ambitious earnings numbers. Additionally, the company is dealing with two situations that the founders would like to keep from the auditors: 1) The company has been using free, unsecured public Wi-Fi to take orders via the Internet. The customer may pay via the Internet. Several students, who all happen to be members of the same student organization on campus, are claiming that using Campus Fast has allowed their identity to be stolen. One student is claiming that she had $12,000 of charges on her credit card to the unsecured Internet site of Campus Fast. Management plans to pay off the complaining students and keep the true liability off the balance sheet. "An interest buyer has about the unsecured site and might get scared by the student complaints". 2) The company guarantees fast delivery. It has offered to pay any speeding or other moving violation tickets to its delivery drivers. Unfortunately one of the drivers was involved in an accident due to running a red light. The passenger in the other car is in critical condition and the intensive care unit in the hospital. The driver has promised the family of the passenger that the company will make good on any expenses and admitted the company policy on repaying all traffic tickets. Attorneys for the injured party are threatening to sue and publicize the situation. The founders do not have enough cash to take care of this problem but are still trying to keep the situation from the auditors and potential buyer. Using the internal control framework from SAS 55, 98, COSO and Enterprise Risk Management, assess the internal control and risks of Campus Fast. The students should discuss the control environment of Campus fast (founders intent on making goals) risk assessment (two potential contingent and actual liabilities that the founders are trying to cover up and keep off the balance sheet), control activities, information and communications systems (liability of using unsecured Wi-Fi), and monitoring.
Chapter 06 Legal and Regulatory Obligations in an Ethical Framework

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1. What is the first general stage in an audit-related dispute as identified by USC Professor Zoe-Vonna Palmrose? A. The occurrence of events that result in losses for users of the financial statements B. An investigation by plaintiff attorneys before filing to link the user losses with allegations that material omissions or misstatements in the financial statements C. The legal process that commences with the filing of a lawsuit D. A public company engages in deliberate activity to "cook the books"
2. The legal precedent that evolves from legal opinions issued by judges in deciding a case and guides judges in deciding similar cases in the future is referred to as: A. Business law B. Tort law C. Common law D. Statutory law
3. In the U.S., if the auditor can demonstrate having performed services with the same degree of skill and judgment possessed by others in the profession, it can be said to have exercised: A. Prudence B. Scienter C. Nonfeasance D. Due Care
4. Which of the following would normally be considered sufficient to demonstrate due care on the part of the auditor? A. The auditor had its work reviewed by another audit firm B. The auditor cites adherence to generally accepted auditing standards (GAAS) C. No omissions or misstatements have been found in the client's financial statements D. The auditor signs a statement expressing its unqualified opinion as to the fairness of the financial statements
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5. A privity relationship means that A. A party may be a user of the financial statements B. A party may sue if fraud has taken place C. A party's financial liability is limited D. A party has a contractual obligation
6. The Ultramares v. Touche case of 1933 held that a cause of action based on negligence could not be maintained by a third party who was not in contractual privity; however, it did leave open the possibility that: A. Third parties that were "foreseeable" may sue for ordinary negligence B. Third parties may sue if one of the parties in contractual privity allowed it to C. Third parties may sue in the case of fraud or constructive fraud D. Third parties who used the financial statements may sue
7. The Restatement (Second) of Torts Approach A. Expands an accountant's legal liability to third parties identified by the client as intended recipients of work B. Limits an accountant's legal liability to only those parties with which it has a privity relationship C. Limits an accountant's legal liability to only those parties that have been named by the client D. Expands an accountant's legal liability to all possible users of the audited financial statements
8. The Rosenblum case ruling was of concern to the accounting profession because it implied that A. Full joint and several liabilities would be reinstated. B. All possible third party users of financial statements must be anticipated. C. The concept of contractual privity would no longer be important. D. Financial liability would occur when scienter was a factor.
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9. The Credit Alliance v. Arthur Andersen & Co. case established three tests that must be satisfied for holding auditors liable for negligence to third parties. All of the following are tests described EXCEPT A. Knowledge by the accountant that the financial statements are to be used for a particular purpose. B. The intention of the third party to rely on those statements. C. Some action by the accountant linking him or her to the third party that provides evidence of the accountant's understanding of intended reliance. D. The identity of the third party must be directly known to the auditor.
10. When an auditor acts so carelessly in the application of professional standards that it implies a reckless disregard for the standards of due care is referred to as A. Scienter B. Fraud C. Constructive fraud D. Negligence
11. When courts find accountants liable for constructive fraud, the implication is that A. Auditors should always be liable when investors lose money due to deceit B. Accountants may be liable for fraud even when they had no knowledge of deceit C. Auditors should be able to detect all deceit by management D. Accountants may be held liable even to third parties to whom they did not have a duty
12. All of the following proof can be used in an auditor's defense against third party lawsuits for fraud except for: A. The third party was not in contractual privity B. The auditor did not have a duty to the third party C. The third party was negligent D. The third party did not suffer a loss
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13. An audit engagement letter A. Offers an auditor's services to a client B. Is required by generally accepted auditing standards (GAAS) C. Details the SEC's expectations for the audit firm for a specific engagement D. Formalizes the relationship between the auditor and the client for a specific engagement
14. The most relevant sources of civil liabilities for auditors failing to adhere to the requirements of the laws in carrying out professional obligations include all of the following except for: A. Securities Act of 1933 B. Private Securities Litigation Reform Act of 1995 C. Securities and Exchange Act of 1934 D. Sarbanes-Oxley Act of 2002
15. The Securities Act of 1933 A. Regulates the auditing of financial statements for publicly-traded companies B. Limits the financial liability of independent auditors except in the case of gross negligence C. Regulates the initial offering of securities D. Regulates which services may be performed for a publicly-traded company by an audit firm
16. Under the Securities Act of 1933, if damages were incurred and there was a material misstatement or omission in the financial statements, the CPA automatically loses unless A. The management intentionally deceived the auditors B. The damages were incurred to a third party that was not a signatory to the contract C. The CPA can shift the burden of proof to the investors D. The CPA rebuts the allegations
17. The executives of McKesson and Robbins Pharmaceuticals were able to steal around $2.9 million in 1939 because A. Its auditors did not follow the generally accepted auditing standards (GAAS) of the time B. The independent audit of financial statements was not required at the time C. Physical inspection of inventory was not performed by the auditors D. The auditors were not independent and conspired with management to steal the funds
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18. The Securities and Exchange Act of 1934 A. Limits the financial liability of independent auditors except in the case of gross negligence B. Requires the filing of audited annual statements and reviewed quarterly statements C. Regulates the initial offering financial statements of securities D. Regulates which services may be performed for a publicly-traded company by an audit firm
19. Under the Securities Act of 1933 and the Securities and Exchange Act of 1934, accountants may be subject to criminal penalties for: A. Obstruction of justice B. Securities fraud C. Willful violations of the acts D. All of the above
20. The legal term for the intent to deceive, manipulate or defraud is A. Nonfeasance B. Misfeasance C. Constructive fraud D. Scienter
21. In the Jacobs v Coopers & Lybrand case, plaintiffs alleged that Coopers: A. Failed to properly audit the company's accounts receivable from two of its suppliers B. Turned a blind eye to red flags C. Failed to follow the standards of ordinary care D. All of the above
22. In the case of Equity Funding, the audit client A. Fraudulently recorded inventories that did not in fact exist B. Inflated its earnings by recording fictitious sales of insurance policies C. Moved liabilities off the balance sheet by using thousands of subsidiaries D. Recorded inventory below cost, therefore understating costs of goods sold and overstating net income
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23. What is the lesson from "Crazy Eddie" Antar? A. His prices were insane B. Do not flee from the police because they will eventually find you C. Accountants cannot afford to trust anyone D. Financial fraud will always eventually reveal itself because it is unsustainable
24. "Disgorgement" with respect to legal rulings refers to A. A defendant being forced to at least partially repay fraudulently gained money B. An auditor being forced to reveal private client information because fraud has occurred C. An auditor being held financially liable for investor losses D. Giving up one's dinner after food poisoning
25. The Foreign Corrupt Practices Act (FCPA) forbids which kind of bribery: A. U.S. business payments to foreign government/official to be awarded a major contract B. U.S. business payments to a foreign customs official to ensure off-loading of merchandise C. U.S. business payments to U.S. government official to be awarded a major contract D. All of the above
26. A payment made to a foreign government official to ensure that s/he does what is expected given their job requirements can be characterized as a: A. Bribe B. Asset misappropriation C. Facilitating Payment D. Legal Payment
27. The Private Securities Litigation Reform Act of 1995 applies the practice of ______. A. Risk assessment B. Fraud triangle C. Lowballing D. Proportionate liability
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28. What is a worrisome consequence under the joint and several liability principles? A. Each negligent party is liable for the portion of the damages for which it is responsible B. All negligent parties are always liable for damages C. Only the negligent party considered to have "deep pockets" is held liable for damages D. Each negligent party could be held liable for the total of damages suffered
29. Which of the following would be a logical consequence of the Private Securities Litigation Reform Act of 1995? A. Each negligent party is only liable for the portion of damages for which it is responsible B. Each negligent party could be held liable for the total of damages suffered C. Auditors have tended to neglect their responsibility of due diligence D. The threat of private enforcement against accountants has increased
30. Under the Private Securities Litigation Reform Act, if an auditor concludes that an illegal act with a material effect on the financial statements has been reported to, but not dealt with by senior management, the auditor should then report his/her conclusions to A. The Securities and Exchange Commission B. The company's board of directors C. The office of the controller/comptroller for the appropriate state D. The Federal Bureau of Investigation
31. Under the rules of the Sarbanes-Oxley Act of 2002, who must certify the public reports filed with the SEC? A. The independent auditor B. The CEO C. The CEO and CFO D. The CEO and controller
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32. Under section 801 of the Sarbanes-Oxley Act of 2002, anyone who "knowing alters, destroys, mutilates, conceals, covers up, falsifies, or makes false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation" is subject to certain penalties. How long after the end of the fiscal period in which the audit or review was concluded are auditors required to retain work papers? A. 1 year B. 7 years C. Indefinitely D. 5 years
33. There are two kinds of whistle blowing, A. Internal and external B. Direct and indirect C. Explicit and implicit D. Anonymous and public
34. How long do management and the audit committee have to act if the independent auditor reports possible illegal acts to them? A. One week B. One month C. Three business days D. One business day
35. What argument can be made that Sarbanes-Oxley may not be effective in reducing fraud? A. It is not as stringent as international standards B. The SEC has had many laws for many years that have not seemed to make much of a difference C. The penalties under Sarbanes-Oxley are especially stringent, so it may not be enforced D. Civil and criminal penalties are not effective in preventing financial fraud
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36. The SEC attempts to control insider trading in part by: A. Prohibiting officers and directors from buying stock of the company they work for/oversee B. Prohibiting shareholders from buying stock of affiliated companies C. Requiring officers, directors, and shareholders owning 10 percent of the class of equity securities registered with the SEC to file reports concerning their ownership and trading of the corporations securities D. All of the above
37. Martha Stewart was found guilty of which offense with respect to her sale of ImClone stock? A. Insider trading B. Obstruction of justice C. Fraud D. Dressing poorly when she sold the stock
38. Section 801 of the Sarbanes-Oxley Act makes it a crime to: A. Knowingly altering or destroying records or documents related to an audit B. Insider trading C. Knowingly making a false entry in a record or document with the intent to impede, obstruct, or otherwise influence an investigation with respect to the audit D. All of the above
39. In order for an employee to bring an action under Section 806 of the Sarbanes-Oxley Act in a whistle blowing case: A. The employee suffered an unfavorable personnel action B. The employee must be engaged in a protected activity or conduct and the circumstances were sufficient to raise the inference that the protected activity was a contributing factor to the unfavorable action C. The employer knew actually or constructively that the conduct occurred D. All of the above
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40. The major purpose of the amended Federal Sentencing Guidelines is to: A. Allow federal judges to mitigate any sentence imposed on a company according to a mathematical formula B. Extend the statute of limitations for bringing a lawsuit for fraud against an auditor to seven years C. Criminalize the bribery of foreign government/officials D. Allow a plaintiff to bring a lawsuit under the law for managers' or board of directors' breach of fiduciary duty
41. Which two organizations were formed to deal with the accounting profession's credibility? A. AICPA and Macdonald B. Treadway and SEC C. Treadway and AICPA D. Treadway and Macdonald
42. What is a payment made to someone in a government agency in order to obtain approval or assistance from that individual or organization called? A. Facilitating Payment B. Bribe C. Grease D. Legal Payment
43. Which Act requires firms who engaged in international operations to have internal controls and an audit committee? A. The Foreign Corrupt Practices Act of 1977 B. The Foreign Exchange Regulation Act of 1973 C. The Foreign Exchange Management Act of 1999 D. The Foreign Management Practices Act of 1977
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44. The difference between an auditor's services regarding reports 10Q and 10K is A. The auditor provides "limited assurance" regarding 10Q and "reasonable assurance" regarding 10K B. The auditor provides "reasonable assurance" regarding 10Q and "limited assurance" regarding 10K C. The auditor provides no assurance regarding 10Q and "limited assurance" regarding 10K D. The auditor provides "limited assurance" regarding 10Q and "absolute assurance" regarding 10K
45. Negligent nonfeasance would be said to occur when A. An auditor issues an unqualified opinion for financial statements he or she knows to be materially misstated B. An auditor fails to use appropriate accounting procedures and thereby fails to discover a client's internal practices C. An auditor fails to report an instance of financial fraud to the SEC D. An auditor intentionally skips parts of the audit plan to cut costs and increase profitability
46. The term "manipulative" connotes A. Gross negligence B. Constructive fraud C. Nonfeasance which results in investor losses D. Intentional or will conduct designed to deceive
47. The best defense for an auditor is to A. Perform audits in accordance with ethical principles when auditing standards are unclear B. Strictly adhere to the requirements of the generally agreed auditing principles (GAAS) C. Perform all work not only in accordance with US GAAS but also international GAAS D. Always follow the letter of the law when performing audits
48. Auditors deserve blame in failing to uncover fraud in the Equity Funding case due to A. Failing to determine that some journal entries were phony B. Failing to recognize that many insurance policy files were forged C. Failing to meet some policyholders in person D. Failing to secure the audit plan
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49. All of the following are crimes EXCEPT A. Providing payments to foreign government officials to obtain business. B. Bribing foreign political parties to promote enacting more advantageous trade legislation. C. Providing monetary assistance to a foreign political candidate with the understanding that if he or she wins, the company will get a bigger contract. D. Making payments to a ministerial government employee of a foreign country to obtain a license to do business in that country.
50. Regarding criminal sentences for illegal business conduct, the recommended sentence range depends primarily upon A. How much money investors lost as a result of the illegal conduct B. The length of the period in which the illegal conduct took place C. The number of investors who lost money as a result of the illegal conduct D. The opinion of the judge as to how egregious the illegal conduct was
51. In which type of court case is proving "due diligence" essential to the auditor's defense? A. Court cases brought under the Securities Exchange Act of 1933 B. Court cases brought under the Securities Exchange Act of 1934 C. Court cases brought by clients under common law D. Court cases brought by third parties under common law
52. In the case of SEC v. Halliburton & KBR, the commission charged Halliburton & KBR with: A. Bribing Nigerian government officials to look the other way while the companies developed and presented fraudulent financial statements B. Bribing Nigerian government officials in order to obtain construction contracts C. Bribing Nigerian government officials to off-load merchandise at the country's piers D. All of the above
53. An important issue in the Hewlett Packard case was: A. Sexting B. Pretexting C. Twittering D. Financial statement fraud
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54. A major allegation in the XTO Energy case was the: A. Breach of fiduciary duties of the board of directors B. Insider trading C. Violation of the FCPA D. All of the above
55. The defendant-auditors in the Anjoorian case argued, in their defense, that: A. To be found guilty to third parties, the court must find that an accountant had contemplated a specific transaction for which the financial statement will be used and that no such transaction was contemplated. B. They had no liability to third party shareholders. C. The plaintiff's theory of damages is speculative and against public policy. D. All of the above.
56. The Knowledgeware case dealt with which accounting issue? A. Overstated inventory amounts B. Sham software sales C. Fictitious invoices D. Overstated net realizable value of receivables
57. The main focus of the Con-Way case is the company's: A. Bribery of Philippine customs officials B. Payments to foreign officials at state-owned airlines doing business in the Philippines C. Failure to properly record and disclose illicit payments to Philippine customs officials and officials at state-owned airlines doing business in the Philippines D. All of the above
58. A key consideration in deciding whether the shareholders in the Countrywide Corporation case would be successful in their lawsuit against members of the board of directors was application of: A. Proportionate liability B. Scienter C. Business judgment rule D. Privity rule
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59. A unique aspect of the lawsuit in Welch v. Cardinal Bankshares Corporation is it: A. Was the first case to deal with the certification of false financial statements by the CEO and CFO thereby violating the Sarbanes-Oxley Act B. Was the first case where an individual brought a complaint against an employer under the whistle blowing provisions of the Sarbanes-Oxley Act C. Reversed the ruling in Ultramares v. Touche D. Reversed the ruling in Bily v. Arthur Young
60. Michael Trent Reznor, the lead singer in the band Nine Inch Nails, filed a lawsuit against Richard Szekelyi and the Navigent Group in the Reznor v JAM, Inc case alleging: A. Negligence B. Breach of fiduciary duty C. Aiding and abetting fraud D. All of the above
61. The SEC v. Zurich Financial Services case dealt with: A. Zurich's use of finite reinsurance transactions to inflate improperly financial performance B. Zurich's use of false insurance invoices to inflate revenues C. Failure of Zurich's board of directors to carry out its fiduciary duties D. Failure of the auditors to exercise the degree of care and professional skepticism expected in an audit
Essay Questions
62. Explain the duty of care of managers and directors. Include in your explanation the role of ethics in making decisions that support such a level of care.
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63. Distinguish between an auditor's legal liability under common law and statutory law. Cite specific cases to support your Answer.
64. What are the best defenses that an auditor can use to defend oneself against charges of fraud? How does ethical behavior relate to these defenses?
65. Distinguish between an auditor's legal liability under the Securities Act of 1933 and the Securities and Exchange Act of 1934.
66. Explain the accounting issues involved and ethical lapses in one of the following two cases: (a) Equity Funding or (2) Crazy Eddie.
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67. The Jacobs v Coopers & Lybrand case deals with the issue of just how egregious an accounting firm's failure to comply with GAAS and GAAP have to be to subject that firm to a fraud claim arising out of its audit of financial statements. Describe the facts of the case and evaluate the plaintiffs' alleged violations by Coopers with respect to GAAS and GAAP.
68. Is insider trading always unethical? If you answer that it is explain why such an action violates ethical standards. If you say that it is not, explain why such an action does not violate ethical actions.
69. The Private Securities Litigation Reform Act of 1995 changed the legal climate in the U.S. in a major way. Explain the nature of the changes under the PSLRA with respect to legal liability. Do you believe this act adequately protects shareholders and other third parties that might bring a lawsuit actions auditor and other defendants? Why or why not?
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70. Which of the provisions of the Sarbanes Oxley Act do you think is the most important? Why did you choose that particular provision?
71. Do you think there can ever be enough laws on the books to reduce or eliminate unethical actions that have lead to the many lawsuits discussed in the chapter? Why or why not?
72. Auditors may be held liable to both their clients and third parties under common law. a. What must a client prove to recover its losses from a client under common law? b. What must an ordinary third party prove to recover losses from an auditor under common law? c. How does an auditor's ethical obligations and liability under common law intersect?
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73. A student states that as long as the auditor has followed all applicable laws, then the auditor has been ethical. Do you agree? Why or why not?
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Chapter 06 Legal and Regulatory Obligations in an Ethical Framework Answer Key
1. What is the first general stage in an audit-related dispute as identified by USC Professor Zoe-Vonna Palmrose? A. The occurrence of events that result in losses for users of the financial statements B. An investigation by plaintiff attorneys before filing to link the user losses with allegations that material omissions or misstatements in the financial statements C. The legal process that commences with the filing of a lawsuit D. A public company engages in deliberate activity to "cook the books"
2. The legal precedent that evolves from legal opinions issued by judges in deciding a case and guides judges in deciding similar cases in the future is referred to as: A. Business law B. Tort law C. Common law D. Statutory law
3. In the U.S., if the auditor can demonstrate having performed services with the same degree of skill and judgment possessed by others in the profession, it can be said to have exercised: A. Prudence B. Scienter C. Nonfeasance D. Due Care
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4. Which of the following would normally be considered sufficient to demonstrate due care on the part of the auditor? A. The auditor had its work reviewed by another audit firm B. The auditor cites adherence to generally accepted auditing standards (GAAS) C. No omissions or misstatements have been found in the client's financial statements D. The auditor signs a statement expressing its unqualified opinion as to the fairness of the financial statements
5. A privity relationship means that A. A party may be a user of the financial statements B. A party may sue if fraud has taken place C. A party's financial liability is limited D. A party has a contractual obligation
6. The Ultramares v. Touche case of 1933 held that a cause of action based on negligence could not be maintained by a third party who was not in contractual privity; however, it did leave open the possibility that: A. Third parties that were "foreseeable" may sue for ordinary negligence B. Third parties may sue if one of the parties in contractual privity allowed it to C. Third parties may sue in the case of fraud or constructive fraud D. Third parties who used the financial statements may sue
7. The Restatement (Second) of Torts Approach A. Expands an accountant's legal liability to third parties identified by the client as intended recipients of work B. Limits an accountant's legal liability to only those parties with which it has a privity relationship C. Limits an accountant's legal liability to only those parties that have been named by the client D. Expands an accountant's legal liability to all possible users of the audited financial statements
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8. The Rosenblum case ruling was of concern to the accounting profession because it implied that A. Full joint and several liabilities would be reinstated. B. All possible third party users of financial statements must be anticipated. C. The concept of contractual privity would no longer be important. D. Financial liability would occur when scienter was a factor.
9. The Credit Alliance v. Arthur Andersen & Co. case established three tests that must be satisfied for holding auditors liable for negligence to third parties. All of the following are tests described EXCEPT A. Knowledge by the accountant that the financial statements are to be used for a particular purpose. B. The intention of the third party to rely on those statements. C. Some action by the accountant linking him or her to the third party that provides evidence of the accountant's understanding of intended reliance. D. The identity of the third party must be directly known to the auditor.
10. When an auditor acts so carelessly in the application of professional standards that it implies a reckless disregard for the standards of due care is referred to as A. Scienter B. Fraud C. Constructive fraud D. Negligence
11. When courts find accountants liable for constructive fraud, the implication is that A. Auditors should always be liable when investors lose money due to deceit B. Accountants may be liable for fraud even when they had no knowledge of deceit C. Auditors should be able to detect all deceit by management D. Accountants may be held liable even to third parties to whom they did not have a duty
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12. All of the following proof can be used in an auditor's defense against third party lawsuits for fraud except for: A. The third party was not in contractual privity B. The auditor did not have a duty to the third party C. The third party was negligent D. The third party did not suffer a loss
13. An audit engagement letter A. Offers an auditor's services to a client B. Is required by generally accepted auditing standards (GAAS) C. Details the SEC's expectations for the audit firm for a specific engagement D. Formalizes the relationship between the auditor and the client for a specific engagement
14. The most relevant sources of civil liabilities for auditors failing to adhere to the requirements of the laws in carrying out professional obligations include all of the following except for: A. Securities Act of 1933 B. Private Securities Litigation Reform Act of 1995 C. Securities and Exchange Act of 1934 D. Sarbanes-Oxley Act of 2002
15. The Securities Act of 1933 A. Regulates the auditing of financial statements for publicly-traded companies B. Limits the financial liability of independent auditors except in the case of gross negligence C. Regulates the initial offering of securities D. Regulates which services may be performed for a publicly-traded company by an audit firm
16. Under the Securities Act of 1933, if damages were incurred and there was a material misstatement or omission in the financial statements, the CPA automatically loses unless A. The management intentionally deceived the auditors B. The damages were incurred to a third party that was not a signatory to the contract C. The CPA can shift the burden of proof to the investors D. The CPA rebuts the allegations
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17. The executives of McKesson and Robbins Pharmaceuticals were able to steal around $2.9 million in 1939 because A. Its auditors did not follow the generally accepted auditing standards (GAAS) of the time B. The independent audit of financial statements was not required at the time C. Physical inspection of inventory was not performed by the auditors D. The auditors were not independent and conspired with management to steal the funds
18. The Securities and Exchange Act of 1934 A. Limits the financial liability of independent auditors except in the case of gross negligence B. Requires the filing of audited annual statements and reviewed quarterly statements C. Regulates the initial offering financial statements of securities D. Regulates which services may be performed for a publicly-traded company by an audit firm
19. Under the Securities Act of 1933 and the Securities and Exchange Act of 1934, accountants may be subject to criminal penalties for: A. Obstruction of justice B. Securities fraud C. Willful violations of the acts D. All of the above
20. The legal term for the intent to deceive, manipulate or defraud is A. Nonfeasance B. Misfeasance C. Constructive fraud D. Scienter
21. In the Jacobs v Coopers & Lybrand case, plaintiffs alleged that Coopers: A. Failed to properly audit the company's accounts receivable from two of its suppliers B. Turned a blind eye to red flags C. Failed to follow the standards of ordinary care D. All of the above
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22. In the case of Equity Funding, the audit client A. Fraudulently recorded inventories that did not in fact exist B. Inflated its earnings by recording fictitious sales of insurance policies C. Moved liabilities off the balance sheet by using thousands of subsidiaries D. Recorded inventory below cost, therefore understating costs of goods sold and overstating net income
23. What is the lesson from "Crazy Eddie" Antar? A. His prices were insane B. Do not flee from the police because they will eventually find you C. Accountants cannot afford to trust anyone D. Financial fraud will always eventually reveal itself because it is unsustainable
24. "Disgorgement" with respect to legal rulings refers to A. A defendant being forced to at least partially repay fraudulently gained money B. An auditor being forced to reveal private client information because fraud has occurred C. An auditor being held financially liable for investor losses D. Giving up one's dinner after food poisoning
25. The Foreign Corrupt Practices Act (FCPA) forbids which kind of bribery: A. U.S. business payments to foreign government/official to be awarded a major contract B. U.S. business payments to a foreign customs official to ensure off-loading of merchandise C. U.S. business payments to U.S. government official to be awarded a major contract D. All of the above
26. A payment made to a foreign government official to ensure that s/he does what is expected given their job requirements can be characterized as a: A. Bribe B. Asset misappropriation C. Facilitating Payment D. Legal Payment
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27. The Private Securities Litigation Reform Act of 1995 applies the practice of ______. A. Risk assessment B. Fraud triangle C. Lowballing D. Proportionate liability
28. What is a worrisome consequence under the joint and several liability principles? A. Each negligent party is liable for the portion of the damages for which it is responsible B. All negligent parties are always liable for damages C. Only the negligent party considered to have "deep pockets" is held liable for damages D. Each negligent party could be held liable for the total of damages suffered
29. Which of the following would be a logical consequence of the Private Securities Litigation Reform Act of 1995? A. Each negligent party is only liable for the portion of damages for which it is responsible B. Each negligent party could be held liable for the total of damages suffered C. Auditors have tended to neglect their responsibility of due diligence D. The threat of private enforcement against accountants has increased
30. Under the Private Securities Litigation Reform Act, if an auditor concludes that an illegal act with a material effect on the financial statements has been reported to, but not dealt with by senior management, the auditor should then report his/her conclusions to A. The Securities and Exchange Commission B. The company's board of directors C. The office of the controller/comptroller for the appropriate state D. The Federal Bureau of Investigation
31. Under the rules of the Sarbanes-Oxley Act of 2002, who must certify the public reports filed with the SEC? A. The independent auditor B. The CEO C. The CEO and CFO D. The CEO and controller
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32. Under section 801 of the Sarbanes-Oxley Act of 2002, anyone who "knowing alters, destroys, mutilates, conceals, covers up, falsifies, or makes false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation" is subject to certain penalties. How long after the end of the fiscal period in which the audit or review was concluded are auditors required to retain work papers? A. 1 year B. 7 years C. Indefinitely D. 5 years
33. There are two kinds of whistle blowing, A. Internal and external B. Direct and indirect C. Explicit and implicit D. Anonymous and public
34. How long do management and the audit committee have to act if the independent auditor reports possible illegal acts to them? A. One week B. One month C. Three business days D. One business day
35. What argument can be made that Sarbanes-Oxley may not be effective in reducing fraud? A. It is not as stringent as international standards B. The SEC has had many laws for many years that have not seemed to make much of a difference C. The penalties under Sarbanes-Oxley are especially stringent, so it may not be enforced D. Civil and criminal penalties are not effective in preventing financial fraud
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36. The SEC attempts to control insider trading in part by: A. Prohibiting officers and directors from buying stock of the company they work for/oversee B. Prohibiting shareholders from buying stock of affiliated companies C. Requiring officers, directors, and shareholders owning 10 percent of the class of equity securities registered with the SEC to file reports concerning their ownership and trading of the corporations securities D. All of the above
37. Martha Stewart was found guilty of which offense with respect to her sale of ImClone stock? A. Insider trading B. Obstruction of justice C. Fraud D. Dressing poorly when she sold the stock
38. Section 801 of the Sarbanes-Oxley Act makes it a crime to: A. Knowingly altering or destroying records or documents related to an audit B. Insider trading C. Knowingly making a false entry in a record or document with the intent to impede, obstruct, or otherwise influence an investigation with respect to the audit D. All of the above
39. In order for an employee to bring an action under Section 806 of the Sarbanes-Oxley Act in a whistle blowing case: A. The employee suffered an unfavorable personnel action B. The employee must be engaged in a protected activity or conduct and the circumstances were sufficient to raise the inference that the protected activity was a contributing factor to the unfavorable action C. The employer knew actually or constructively that the conduct occurred D. All of the above
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40. The major purpose of the amended Federal Sentencing Guidelines is to: A. Allow federal judges to mitigate any sentence imposed on a company according to a mathematical formula B. Extend the statute of limitations for bringing a lawsuit for fraud against an auditor to seven years C. Criminalize the bribery of foreign government/officials D. Allow a plaintiff to bring a lawsuit under the law for managers' or board of directors' breach of fiduciary duty
41. Which two organizations were formed to deal with the accounting profession's credibility? A. AICPA and Macdonald B. Treadway and SEC C. Treadway and AICPA D. Treadway and Macdonald
42. What is a payment made to someone in a government agency in order to obtain approval or assistance from that individual or organization called? A. Facilitating Payment B. Bribe C. Grease D. Legal Payment
43. Which Act requires firms who engaged in international operations to have internal controls and an audit committee? A. The Foreign Corrupt Practices Act of 1977 B. The Foreign Exchange Regulation Act of 1973 C. The Foreign Exchange Management Act of 1999 D. The Foreign Management Practices Act of 1977
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44. The difference between an auditor's services regarding reports 10Q and 10K is A. The auditor provides "limited assurance" regarding 10Q and "reasonable assurance" regarding 10K B. The auditor provides "reasonable assurance" regarding 10Q and "limited assurance" regarding 10K C. The auditor provides no assurance regarding 10Q and "limited assurance" regarding 10K D. The auditor provides "limited assurance" regarding 10Q and "absolute assurance" regarding 10K
45. Negligent nonfeasance would be said to occur when A. An auditor issues an unqualified opinion for financial statements he or she knows to be materially misstated B. An auditor fails to use appropriate accounting procedures and thereby fails to discover a client's internal practices C. An auditor fails to report an instance of financial fraud to the SEC D. An auditor intentionally skips parts of the audit plan to cut costs and increase profitability
46. The term "manipulative" connotes A. Gross negligence B. Constructive fraud C. Nonfeasance which results in investor losses D. Intentional or will conduct designed to deceive
47. The best defense for an auditor is to A. Perform audits in accordance with ethical principles when auditing standards are unclear B. Strictly adhere to the requirements of the generally agreed auditing principles (GAAS) C. Perform all work not only in accordance with US GAAS but also international GAAS D. Always follow the letter of the law when performing audits
48. Auditors deserve blame in failing to uncover fraud in the Equity Funding case due to A. Failing to determine that some journal entries were phony B. Failing to recognize that many insurance policy files were forged C. Failing to meet some policyholders in person D. Failing to secure the audit plan
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49. All of the following are crimes EXCEPT A. Providing payments to foreign government officials to obtain business. B. Bribing foreign political parties to promote enacting more advantageous trade legislation. C. Providing monetary assistance to a foreign political candidate with the understanding that if he or she wins, the company will get a bigger contract. D. Making payments to a ministerial government employee of a foreign country to obtain a license to do business in that country.
50. Regarding criminal sentences for illegal business conduct, the recommended sentence range depends primarily upon A. How much money investors lost as a result of the illegal conduct B. The length of the period in which the illegal conduct took place C. The number of investors who lost money as a result of the illegal conduct D. The opinion of the judge as to how egregious the illegal conduct was
51. In which type of court case is proving "due diligence" essential to the auditor's defense? A. Court cases brought under the Securities Exchange Act of 1933 B. Court cases brought under the Securities Exchange Act of 1934 C. Court cases brought by clients under common law D. Court cases brought by third parties under common law
52. In the case of SEC v. Halliburton & KBR, the commission charged Halliburton & KBR with: A. Bribing Nigerian government officials to look the other way while the companies developed and presented fraudulent financial statements B. Bribing Nigerian government officials in order to obtain construction contracts C. Bribing Nigerian government officials to off-load merchandise at the country's piers D. All of the above
53. An important issue in the Hewlett Packard case was: A. Sexting B. Pretexting C. Twittering D. Financial statement fraud
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54. A major allegation in the XTO Energy case was the: A. Breach of fiduciary duties of the board of directors B. Insider trading C. Violation of the FCPA D. All of the above
55. The defendant-auditors in the Anjoorian case argued, in their defense, that: A. To be found guilty to third parties, the court must find that an accountant had contemplated a specific transaction for which the financial statement will be used and that no such transaction was contemplated. B. They had no liability to third party shareholders. C. The plaintiff's theory of damages is speculative and against public policy. D. All of the above.
56. The Knowledgeware case dealt with which accounting issue? A. Overstated inventory amounts B. Sham software sales C. Fictitious invoices D. Overstated net realizable value of receivables
57. The main focus of the Con-Way case is the company's: A. Bribery of Philippine customs officials B. Payments to foreign officials at state-owned airlines doing business in the Philippines C. Failure to properly record and disclose illicit payments to Philippine customs officials and officials at state-owned airlines doing business in the Philippines D. All of the above
58. A key consideration in deciding whether the shareholders in the Countrywide Corporation case would be successful in their lawsuit against members of the board of directors was application of: A. Proportionate liability B. Scienter C. Business judgment rule D. Privity rule
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59. A unique aspect of the lawsuit in Welch v. Cardinal Bankshares Corporation is it: A. Was the first case to deal with the certification of false financial statements by the CEO and CFO thereby violating the Sarbanes-Oxley Act B. Was the first case where an individual brought a complaint against an employer under the whistle blowing provisions of the Sarbanes-Oxley Act C. Reversed the ruling in Ultramares v. Touche D. Reversed the ruling in Bily v. Arthur Young
60. Michael Trent Reznor, the lead singer in the band Nine Inch Nails, filed a lawsuit against Richard Szekelyi and the Navigent Group in the Reznor v JAM, Inc case alleging: A. Negligence B. Breach of fiduciary duty C. Aiding and abetting fraud D. All of the above
61. The SEC v. Zurich Financial Services case dealt with: A. Zurich's use of finite reinsurance transactions to inflate improperly financial performance B. Zurich's use of false insurance invoices to inflate revenues C. Failure of Zurich's board of directors to carry out its fiduciary duties D. Failure of the auditors to exercise the degree of care and professional skepticism expected in an audit
Essay Questions
62. Explain the duty of care of managers and directors. Include in your explanation the role of ethics in making decisions that support such a level of care. Answers will vary
63. Distinguish between an auditor's legal liability under common law and statutory law. Cite specific cases to support your Answer. Answers will vary
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64. What are the best defenses that an auditor can use to defend oneself against charges of fraud? How does ethical behavior relate to these defenses? Answers will vary
65. Distinguish between an auditor's legal liability under the Securities Act of 1933 and the Securities and Exchange Act of 1934. Answers will vary
66. Explain the accounting issues involved and ethical lapses in one of the following two cases: (a) Equity Funding or (2) Crazy Eddie. Answers will vary
67. The Jacobs v Coopers & Lybrand case deals with the issue of just how egregious an accounting firm's failure to comply with GAAS and GAAP have to be to subject that firm to a fraud claim arising out of its audit of financial statements. Describe the facts of the case and evaluate the plaintiffs' alleged violations by Coopers with respect to GAAS and GAAP. Answers will vary
68. Is insider trading always unethical? If you answer that it is explain why such an action violates ethical standards. If you say that it is not, explain why such an action does not violate ethical actions. Answers will vary
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69. The Private Securities Litigation Reform Act of 1995 changed the legal climate in the U.S. in a major way. Explain the nature of the changes under the PSLRA with respect to legal liability. Do you believe this act adequately protects shareholders and other third parties that might bring a lawsuit actions auditor and other defendants? Why or why not? Answers will vary
70. Which of the provisions of the Sarbanes Oxley Act do you think is the most important? Why did you choose that particular provision? Answers will vary
71. Do you think there can ever be enough laws on the books to reduce or eliminate unethical actions that have lead to the many lawsuits discussed in the chapter? Why or why not? Answers will vary
72. Auditors may be held liable to both their clients and third parties under common law. a. What must a client prove to recover its losses from a client under common law? b. What must an ordinary third party prove to recover losses from an auditor under common law? c. How does an auditor's ethical obligations and liability under common law intersect? a. To recover losses under common law, a client must prove losses, reliance on the auditors' representations, that the reliance was proximate cause of the losses, and negligence on the part of the auditors. b. To recover losses under common law, ordinary third parties must prove losses, reliance on the auditors' report, that the reliance was proximate cause of the losses, and gross negligence on the part of the auditors. c. The student may use rights, deontology, utilitarianism, or virtue theories to argue that if the auditor does his job, meeting all duties and obligations, then the law and ethical obligations are in alignment.
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73. A student states that as long as the auditor has followed all applicable laws, then the auditor has been ethical. Do you agree? Why or why not? The law represents the minimal moral standards of society. So if an auditor does only what is required by law, the auditor is doing the minimum. By following ethical standards, which go beyond what the law requires, an auditor should minimize his legal liabilities. Students could use any of the ethical theories to justify their stand on this question.
Chapter 07 Earnings Management and the Quality of Financial Reporting

1. If a company is managing its earnings, which of the ethical theories are they most likely following? A. Rights B. Fairness C. Egoism D. Virtue
2. Which of the following is NOT considered "earnings management"? A. "Earnings management" is to project smoother earnings from year to year. B. Managements emphasis on achieving long-term results to meet their financial goals. C. A common practice of "earnings management" is to use "cookie-jar reserves." D. The executives manipulate the earnings in order to match their predetermined target.
3. Which of the following is NOT a motivation to manage earnings? A. Companies try to meet or beat Wall Street earnings projections in order to grow market capitalization and increase the value of stock options. B. The ideal pattern of earnings is volatility each year over a period of time. C. To smooth net income over time. D. To maximize compensation including bonuses.
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4. Which technique was used by both WorldCom and Waste Management to manage earnings? A. Manipulating asset net valuation amounts to minimize operating expenses for a period B. Accelerating the recording of revenue into an earlier period C. Delaying needed repairs to a later period D. All of the above were used
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5. Which of the following author(s) emphasize(s) a "purposeful act by management in pursuit of its own self-interests as might be the case when earnings are manipulated to get the stock price up in advance of the exercise of stock options."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
6. Which of the following authors(s) focus(es) on "management's intent to deceive the stakeholders by using accounting devices to positively influence reported earnings."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
7. Which of the following authors(s) contend(s) "earnings management can be acceptable if linked to the choice of alternative accounting principles and estimates that report higher earnings than other methods might report given the circumstances. Only outright fraud is an unacceptable earnings management action."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
8. Which of the following author(s) define(s) earnings management as "reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
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9. From which perspective might one be able to rationalize the ethics of earnings management? A. From a virtue perspective B. From a utilitarian perspective C. From a rights perspective D. From an ethical perspective
10. In surveys of managers, which technique to manage earnings was considered most acceptable? A. Changing inventory valuation in order to influence earnings B. Accounting manipulation C. Manipulating operating decisions D. Establishing cookie jar reserves
11. Which of the following is NOT a qualitative factor when assessing materiality? A. A misstatement that changes a loss into income or vice versa B. The existence of statutory or regulator reporting requirements that affect materiality thresholds C. The potential effect of the misstatement on trends, especially trends in profitability D. The use of simplistic numerical thresholds and rules of thumb
12. Vorhies identifies four perspectives to help CPAs identify key internal control exceptions under the Sarbanes Oxley Act including: A. An internal control deficiency caused by accounting manipulations B. A large variance in an accounting estimate compared with the actual determined amount C. A misstatement that changes a loss into income or vice versa D. All were identified
13. SAS No. 107 identifies the following aspects of disclosure amounts deemed to be material except for: A. Disclosing an item in one year but not in the next year B. Qualitative aspects of the disclosure C. Quantitative significance of the disclosure D. Professional judgment
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14. Each of the following techniques was used by Gemstar TV Guide International in its accounting fraud: A. Created cookie jar reserves of advertising revenue to smooth net income. B. Engaged in round trip transactions whereby Gemstar paid money to a third party to advertise its services and capitalized that cost while the third party used Gemstar's funds to buy advertising from Gemstar, and the company recorded 100% of that amount as revenue while capitalizing the cost of its advertising payments. C. Recorded revenue under expired, disputed, or non-existent agreements, and properly reported this as licensing and advertising revenue. D. Inflated advertising revenue by improperly recording and reporting revenue amounts from multiple-elements transactions.
15. The best definition of a financial restatement is: A. A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information that was previously reported B. A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information for the current period C. An adjustment of financial information due to an error correction D. All are part of the definition
16. In the Glass Lewis survey of financial statements, a somewhat surprising possible cause of the decline in restatements in 2008 may have been due to: A. Internal control requirements under generally accepted auditing standards B. Identifying materiality amounts based on both quantitative and qualitative factors C. More ethical management D. Relaxation of materiality standards by the SEC
17. The SEC Advisory Committee on Improvements in Financial Reporting identified each of the following as a view of equity and credit analysts about investor's views on materiality and financial statement restatements except for: A. Bright line rules are useful in making materiality judgments. B. Bright line rules are not really useful in making materiality judgments. C. The disclosure provided on restatements is not adequate. D. One of the major costs of restatements is the amount of time between the restatement announcement and the final resolution of the restatement.
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18. Which of the following is NOT an earnings management technique? A. Failing to write down or write off impaired assets. B. Releasing questionable reserves into income. C. Failing to record expenses and related liabilities when future obligations remain. D. Creating an allowance for uncollectible accounts and adjusting it at year end.
19. Which of the following is NOT mentioned in the Xerox's case? A. Xerox misled investors by polishing its reputation on Wall Street and to boost the company's stock price. B. The ethical tone at the top set by CEOs Allaire and Thomas, and CFO Romeril, which equated business success with meeting long-term earnings target. C. Xerox failed to disclose GAAP violations that led to acceleration in the recognition of approximately $3 billion in equipment revenues. D. Xerox recognized a greater amount of revenue on leases in early years than warranted and didn't break out revenues that should have been deferred and recognized in future years.
20. Which of the following earnings management techniques are NOT presented in Lucent Technologies, Inc.'s case? A. Shifting Current Revenue to a later period B. Boosting income with one-time gains C. Recording revenue too soon or of questionable quality D. Shifting current expenses to a later or earlier period
21. Which of the following is NOT true according to Enron's case? A. Fastow developed the concept of buying up oil and gas companies to increase Enron's reserves for future sale. B. Fastow worked to structure ventures that met the conditions under GAAP to keep the partnership activities off Enron's books and on the separate books of the partnership. C. Fastow created SPE that borrowed money from banks and transferred to Enron in a sale of an operating asset no longer needed by Enron. D. The SPE created by Fastow enabled Enron to keep debt off its books while benefiting from transfer and use of the cash borrowed by the SPE.
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22. Which of the following is NOT a technique used by Enron to manage earnings? A. Used reserves to increase earnings when reported amounts were too low. B. Deliberately over stated the allowance for uncollectible and adjusted it downward in future years. C. Used mark-to-market estimates to inflate earnings in violation of GAAP. D. Selected which operating assets to "sell" to the SPEs, affecting the gain on transfer and earnings effect.
23. Xerox leases met the criteria under SFAS No. 13 to be accounted for as "sales-type" lease. What did Xerox's top management do that violated GAAP? A. Xerox recognized the fair value of the equipment leased as income in the period the lease is delivered, less any residual value the equipment is expected to retain once the lease expires. B. Xerox prorated the portion of the lease payments that represents the fee for repair services and copier supplies over the term of lease against the financing income. C. Xerox recognized financing revenue when it is earned over the life of the lease. D. Xerox used the "ROE" method which pulled forward a porting of finance income and recognized it immediately as equipment revenue and the "margin normalization" method which pulled forward a portion of service income and recognized it immediately as equipment revenue.
25. What is the culture at Enron that is discussed in the case? A. Employees worked later and later. B. Employees were evaluated in groups; the goal was to remove the bottom 20% of each group every year. C. Enron had a cutthroat system and encouraged a "yes" culture. D. All of the above.
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26. Which of the following partnership that Enron created eventually lead Enron to an end? A. JEDI B. Cactus C. Chewco D. Ironman
27. What is the original motivation by FASB on SPEs? A. To establish a mechanism to encourage companies to invest in needed assets while keeping related debt of its books. B. To keep the large amount of debt off the books. C. To sell non-producing assets to the SPE. D. To select which assets to sell to the SPEs affecting the gain.
28. There are several aspects of Enron fraud that are dealt with directly in SOX further connecting Enron to reform in the accounting profession. Which of the following is true? A. Prohibiting the provision of internal audit service for audit clients. B. Off-balance-sheet financing activities must be disclosed in the notes to the financial statements. C. Related-party transactions require disclosure in the notes. D. All of the above.
29. The best way to characterize the role of Sherron Watkins in the downfall of Enron is: A. She directed the internal auditors to examine numerous transactions that led to the discovery of the fraud B. She gave in to the pressure of Andy Fastow to go along with materially misstated financial statements C. She was sent to jail even though she cooperated with the government in its case against Enron D. She tried to alert Ken Lay about the accounting scandal at Enron
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30. The basic ethical principle violated by Andy Fastow in his role as Enron's CFO and involvement with SPEs was: A. He lied to top management about what he was doing for the SPEs B. He failed to exercise due care in setting up SPEs C. He had a conflict of interests in his dual roles D. All of the above
31. "Cookie jar reserves" can best be described as: A. Buying a lot of chocolate chip cookies, storing them for when you have a hunger attack, and then releasing them into your stomach. B. Overstating or understating allowances and reversing amounts in the future to smooth out net income over time. C. Accelerating the recording of revenues into an earlier year than is warranted. D. Delaying the recording of expenses to a later year to boost income in the current year.
32. All of the following are examples of "Recording revenue too soon or of questionable quality" except for: A. Recording sales that lack economic substance. B. Recording revenue when future services remain to be provided. C. Recording revenue before shipment or before the customer's unconditional acceptance. D. Recording revenue even though the customer is not obligated to pay.
33. All of the following are examples of "Boosting Income with One-Time Gains" except for: A. Recording sales that lack economic substance. B. Boosting profits by selling undervalued assets. C. Including investment income or gains as part of revenue. D. Including investment income or gains as a reduction in operating expenses.
34. The expression, "Too many corporate managers, auditors, and analysts are participants in a game of nods and winks" is attributable to: A. Barry Minkow B. Jerry Seinfeld C. Bernie Ebbers D. Arthur Levitt
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35. Which of the following is NOT an earnings management technique? A. Recording revenue the customer is obligated to pay B. Recording revenue when future services remain to be provided C. Recording sales that lack economic substance D. Including investment income or gains as part of revenue
36. Which of the following is NOT an aggressive accounting practice? A. Non-GAAP method of capitalization interest on landfill development costs. B. Failure to properly accrue for tax and self-insurance expense. C. Under the accrual method, companies charge warranty costs to operating expense in the year of sale. D. Refusal to write-off permitting and/or project costs on impaired or abandoned landfills.
37. Which of the following is NOT addressed in the Waste Management's case? A. The misstatements represented 10% of pre-tax income, which was not considered material. B. The company employed aggressive accounting practices to enhance its earnings. C. The company used the gain to offset unrelated operating expenses which was not in conformity with GAAP. D. The company's auditor, Arthur Andersen, had engaged in improper professional conduct.
38. In the Xerox case, who was Xerox's auditor? A. Ernst & Young B. Deloitte & Touche C. Arthur Andersen D. KPMG
39. Congress passed the "Sarbanes-Oxley Act" on July 30, 2002. Which of the following is NOT true? A. All reporting companies are required to include in their annual reports a report of management on the company's internal control over financial reporting. B. New audit standards include a prohibition against independent auditors providing many non-audit services and mandatory audit partner rotation. C. Only U.S. companies are subject to the disclosure requirements of the Act. D. The presentation of pro forma information is now required.
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40. Which of the statement regarding PCAOB is NOT true? A. PCAOB stands for Public Company Accounting Oversight Board. B. PCAOB assumes the peer review function over registered CPA firms. C. PCAOB was established before the accounting scandal of Enron. D. PCAOB protects the public interest by oversight of independent audits.
41. "Earnings management either ignores or does not consider the rights of the investors and creditors to receive accurate, reliable and transparent financial statements." This statement is from: A. A virtue perspective B. A utilitarian perspective C. A rights perspective D. A materiality perspective
42. Which of the following is NOT McKee's explanation of "earnings management"? A. A smooth net income by choice does not reflect what investors and creditors need or want to know since it masks true performance. B. It creates a more stable and predictable earnings stream by smoothing net income. C. It is a reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results. D. Earnings management reflects a conscious choice by management to smooth earnings over time and it does not include devices designed to "cook the books."
43. Who identifies seven common financial shenanigans? A. Schipper B. Schilit C. Levitt D. McKee
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44. In the Xerox case, the leases Xerox had signed met the criteria under SFAS No. 13 to be accounted for as: A. Capital leases B. Operating leases C. Bargain purchase option leases D. Sales-type leases
45. Which of the following is NOT a motivation to manage earnings in the Lucent Technology case? A. Realize revenue B. Meet predictions of outside securities analysts C. Meet internal sales target D. Obtain sales bonus
46. The main accounting issues in the Nortel Networks case were: A. Premature revenue recognition and hidden cash reserves B. Capitalization of operating expenses and hidden cash reserves C. Premature revenue recognition and off-balance-sheet entities D. Capitalization of operating expenses and off-balance-sheet entities
47. The swap transactions used in the Solutions Network case to manage earnings can best be described as: A. Going to a swap meet and capitalizing purchases instead of expensing them immediately against swap revenue B. Recording revenue on software systems transactions in an earlier period than when obligated to buy the same in a later period C. Using a cookie jar reserve to delay the recording of revenue into a later period D. Recording as operating revenue on onetime gains from the sale of underperforming assets
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48. The accounting issue in the Cubbies Cable case with respect to cable installations costs is closest to the accounting issue in which case? A. Enron B. Gemstar TV Guide C. Xerox D. WorldCom
49. The element of the fraud triangle most directly dealt with in the Excello Telecommunications case is: A. Pressure/Incentives B. Opportunity C. Rationalization D. Materiality
50. The accounting rule for deferring profit on a sale-leaseback agreement such as the one dealt with in the Florida Transportation case can best be described as: A. The seller-lessee can defer profit on a sale-leaseback transaction if the seller gives up substantially all of the use of the property through the leaseback. B. The seller-lessee can defer profit on a sale-leaseback transaction if the seller retains substantially all of the use of the property through the leaseback. C. Profit can be deferred if the upfront costs exceed future revenues. D. Profit can be deferred if initial revenue exceeds future costs.
51. In the Sweat Hog Construction case, the company tried to manipulate earnings through the use of which accounting technique? A. Cookie jar reserves B. Lease capitalization C. Percentage of completion method D. The Big Bath Theory
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52. Which of the following was not an accounting issue in the Sunbeam case? A. Cookie jar reserves B. Channel stuffing C. Bill and hold sales D. Swap transactions
53. The legal issue in the Altris Software v PricewaterhouseCoopers case that failed to be proved by the plaintiffs was: A. Privity B. Ordinary negligence C. Scienter D. Due care
54. The legal issue in the CellCyte Genetics Corporation case was: A. Making false and misleading statements in several SEC filings B. Making false and misleading statements in a court trial C. Privity D. Scienter
55. The former CEO of Vivendi Universal, Jean-Marie Messier, used as his defense in the case that: A. His actions were protected by attorney-client privilege B. While some of his actions may have turned out to be wrong, there never was an intent to defraud C. While some of his actions may have turned out to be wrong, he did the best that he could to save the company from certain bankruptcy D. He adhere to the business judgment rule and met his fiduciary obligations
Essay Questions
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56. Explain when earnings management may be an ethical practice.
57. Discuss all the factors an auditor should consider in making a materiality judgment.
58. Many of the cases discussed in the chapter address the issue of swap transactions. What is a swap transaction? What criteria should be used to determine how and when to record revenue on swap transactions? Describe the facts of any one case in the book with respect to proper recording for revenue in swap transactions.
59. The amount and size of earnings restatements were relatively high in the early and mid2000s. Explain the reasons that these instances were frequent and amounts high during that period of time.
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60. Explain each of the seven financial shenanigans described by Schilit. Be sure to give an example of each one.
61. Select either the Xerox or Lucent frauds described in the chapter and explain the accounting techniques used to commit fraud.
62. Use the fraud triangle to evaluate the actions by those in top management at Enron as the accounting fraud unfolded.
63. Evaluate the ethics at Enron and by those in top management with respect to its operations and accounting and financial reporting techniques.
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64. The quality of financial reporting is an important issue in the chapter. Explain how and why the quality of financial reporting is an underlying issue in the frauds discussed in the chapter. Answers: Answers will vary
65. Assume you were in Sherron Watkins' position and you informed Ken Lay that the company might implode as a result of the accounting scandal. After an investigation by the lawyers who said there was nothing to worry about, Lay told you he would take no steps to act on your concerns. Use the relevant elements of the decision making model described in chapter 2 including stakeholder and ethical considerations and decide on a course of action for Watkins. Answers: Answers will vary
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66. Steve is quickly moving up in the accounting department of RAC Inc. It is yearend; he has just received news that the estimates of the estimated useful life and salvage values were wrong and must be changed. Of course, that changes the depreciation expense and accumulated depreciation. Steve calls his wife to explain why he will be late again. Now is he is pondering on a comment his wife made. She said "I'm no accountant; but after four years, you would think that the company could get done how its estimates affect expenses and those other accounts." What might the company be doing and what should Steve do from an ethical reasoning view? Answers: The Company is probably managing earnings. Steve can reason from rights, deontology, utilitarianism, or virtue theories. Steve must choose from refusing to assist the company in managing earnings (and probably lose his job) and blowing the whistle. If the Company has a Hotline, Steve may get to choose to be anonymous. Steve may also want to discuss the matter with the audit committee.
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Chapter 07 Earnings Management and the Quality of Financial Reporting Answer Key
1. If a company is managing its earnings, which of the ethical theories are they most likely following? A. Rights B. Fairness C. Egoism D. Virtue
2. Which of the following is NOT considered "earnings management"? A. "Earnings management" is to project smoother earnings from year to year. B. Managements emphasis on achieving long-term results to meet their financial goals. C. A common practice of "earnings management" is to use "cookie-jar reserves." D. The executives manipulate the earnings in order to match their predetermined target.
3. Which of the following is NOT a motivation to manage earnings? A. Companies try to meet or beat Wall Street earnings projections in order to grow market capitalization and increase the value of stock options. B. The ideal pattern of earnings is volatility each year over a period of time. C. To smooth net income over time. D. To maximize compensation including bonuses.
4. Which technique was used by both WorldCom and Waste Management to manage earnings? A. Manipulating asset net valuation amounts to minimize operating expenses for a period B. Accelerating the recording of revenue into an earlier period C. Delaying needed repairs to a later period D. All of the above were used
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5. Which of the following author(s) emphasize(s) a "purposeful act by management in pursuit of its own self-interests as might be the case when earnings are manipulated to get the stock price up in advance of the exercise of stock options."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
6. Which of the following authors(s) focus(es) on "management's intent to deceive the stakeholders by using accounting devices to positively influence reported earnings."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
7. Which of the following authors(s) contend(s) "earnings management can be acceptable if linked to the choice of alternative accounting principles and estimates that report higher earnings than other methods might report given the circumstances. Only outright fraud is an unacceptable earnings management action."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
8. Which of the following author(s) define(s) earnings management as "reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results."? A. Dechow and Skinner B. Healy and Wahlen C. Schipper D. Thomas E. McKee
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9. From which perspective might one be able to rationalize the ethics of earnings management? A. From a virtue perspective B. From a utilitarian perspective C. From a rights perspective D. From an ethical perspective
10. In surveys of managers, which technique to manage earnings was considered most acceptable? A. Changing inventory valuation in order to influence earnings B. Accounting manipulation C. Manipulating operating decisions D. Establishing cookie jar reserves
11. Which of the following is NOT a qualitative factor when assessing materiality? A. A misstatement that changes a loss into income or vice versa B. The existence of statutory or regulator reporting requirements that affect materiality thresholds C. The potential effect of the misstatement on trends, especially trends in profitability D. The use of simplistic numerical thresholds and rules of thumb
12. Vorhies identifies four perspectives to help CPAs identify key internal control exceptions under the Sarbanes Oxley Act including: A. An internal control deficiency caused by accounting manipulations B. A large variance in an accounting estimate compared with the actual determined amount C. A misstatement that changes a loss into income or vice versa D. All were identified
13. SAS No. 107 identifies the following aspects of disclosure amounts deemed to be material except for: A. Disclosing an item in one year but not in the next year B. Qualitative aspects of the disclosure C. Quantitative significance of the disclosure D. Professional judgment
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14. Each of the following techniques was used by Gemstar TV Guide International in its accounting fraud: A. Created cookie jar reserves of advertising revenue to smooth net income. B. Engaged in round trip transactions whereby Gemstar paid money to a third party to advertise its services and capitalized that cost while the third party used Gemstar's funds to buy advertising from Gemstar, and the company recorded 100% of that amount as revenue while capitalizing the cost of its advertising payments. C. Recorded revenue under expired, disputed, or non-existent agreements, and properly reported this as licensing and advertising revenue. D. Inflated advertising revenue by improperly recording and reporting revenue amounts from multiple-elements transactions.
15. The best definition of a financial restatement is: A. A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information that was previously reported B. A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information for the current period C. An adjustment of financial information due to an error correction D. All are part of the definition
16. In the Glass Lewis survey of financial statements, a somewhat surprising possible cause of the decline in restatements in 2008 may have been due to: A. Internal control requirements under generally accepted auditing standards B. Identifying materiality amounts based on both quantitative and qualitative factors C. More ethical management D. Relaxation of materiality standards by the SEC
17. The SEC Advisory Committee on Improvements in Financial Reporting identified each of the following as a view of equity and credit analysts about investor's views on materiality and financial statement restatements except for: A. Bright line rules are useful in making materiality judgments. B. Bright line rules are not really useful in making materiality judgments. C. The disclosure provided on restatements is not adequate. D. One of the major costs of restatements is the amount of time between the restatement announcement and the final resolution of the restatement.
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18. Which of the following is NOT an earnings management technique? A. Failing to write down or write off impaired assets. B. Releasing questionable reserves into income. C. Failing to record expenses and related liabilities when future obligations remain. D. Creating an allowance for uncollectible accounts and adjusting it at year end.
19. Which of the following is NOT mentioned in the Xerox's case? A. Xerox misled investors by polishing its reputation on Wall Street and to boost the company's stock price. B. The ethical tone at the top set by CEOs Allaire and Thomas, and CFO Romeril, which equated business success with meeting long-term earnings target. C. Xerox failed to disclose GAAP violations that led to acceleration in the recognition of approximately $3 billion in equipment revenues. D. Xerox recognized a greater amount of revenue on leases in early years than warranted and didn't break out revenues that should have been deferred and recognized in future years.
21. Which of the following is NOT true according to Enron's case? A. Fastow developed the concept of buying up oil and gas companies to increase Enron's reserves for future sale. B. Fastow worked to structure ventures that met the conditions under GAAP to keep the partnership activities off Enron's books and on the separate books of the partnership. C. Fastow created SPE that borrowed money from banks and transferred to Enron in a sale of an operating asset no longer needed by Enron. D. The SPE created by Fastow enabled Enron to keep debt off its books while benefiting from transfer and use of the cash borrowed by the SPE.
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22. Which of the following is NOT a technique used by Enron to manage earnings? A. Used reserves to increase earnings when reported amounts were too low. B. Deliberately over stated the allowance for uncollectible and adjusted it downward in future years. C. Used mark-to-market estimates to inflate earnings in violation of GAAP. D. Selected which operating assets to "sell" to the SPEs, affecting the gain on transfer and earnings effect.
23. Xerox leases met the criteria under SFAS No. 13 to be accounted for as "sales-type" lease. What did Xerox's top management do that violated GAAP? A. Xerox recognized the fair value of the equipment leased as income in the period the lease is delivered, less any residual value the equipment is expected to retain once the lease expires. B. Xerox prorated the portion of the lease payments that represents the fee for repair services and copier supplies over the term of lease against the financing income. C. Xerox recognized financing revenue when it is earned over the life of the lease. D. Xerox used the "ROE" method which pulled forward a porting of finance income and recognized it immediately as equipment revenue and the "margin normalization" method which pulled forward a portion of service income and recognized it immediately as equipment revenue.
25. What is the culture at Enron that is discussed in the case? A. Employees worked later and later. B. Employees were evaluated in groups; the goal was to remove the bottom 20% of each group every year. C. Enron had a cutthroat system and encouraged a "yes" culture. D. All of the above.
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26. Which of the following partnership that Enron created eventually lead Enron to an end? A. JEDI B. Cactus C. Chewco D. Ironman
27. What is the original motivation by FASB on SPEs? A. To establish a mechanism to encourage companies to invest in needed assets while keeping related debt of its books. B. To keep the large amount of debt off the books. C. To sell non-producing assets to the SPE. D. To select which assets to sell to the SPEs affecting the gain.
28. There are several aspects of Enron fraud that are dealt with directly in SOX further connecting Enron to reform in the accounting profession. Which of the following is true? A. Prohibiting the provision of internal audit service for audit clients. B. Off-balance-sheet financing activities must be disclosed in the notes to the financial statements. C. Related-party transactions require disclosure in the notes. D. All of the above.
29. The best way to characterize the role of Sherron Watkins in the downfall of Enron is: A. She directed the internal auditors to examine numerous transactions that led to the discovery of the fraud B. She gave in to the pressure of Andy Fastow to go along with materially misstated financial statements C. She was sent to jail even though she cooperated with the government in its case against Enron D. She tried to alert Ken Lay about the accounting scandal at Enron
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30. The basic ethical principle violated by Andy Fastow in his role as Enron's CFO and involvement with SPEs was: A. He lied to top management about what he was doing for the SPEs B. He failed to exercise due care in setting up SPEs C. He had a conflict of interests in his dual roles D. All of the above
31. "Cookie jar reserves" can best be described as: A. Buying a lot of chocolate chip cookies, storing them for when you have a hunger attack, and then releasing them into your stomach. B. Overstating or understating allowances and reversing amounts in the future to smooth out net income over time. C. Accelerating the recording of revenues into an earlier year than is warranted. D. Delaying the recording of expenses to a later year to boost income in the current year.
32. All of the following are examples of "Recording revenue too soon or of questionable quality" except for: A. Recording sales that lack economic substance. B. Recording revenue when future services remain to be provided. C. Recording revenue before shipment or before the customer's unconditional acceptance. D. Recording revenue even though the customer is not obligated to pay.
33. All of the following are examples of "Boosting Income with One-Time Gains" except for: A. Recording sales that lack economic substance. B. Boosting profits by selling undervalued assets. C. Including investment income or gains as part of revenue. D. Including investment income or gains as a reduction in operating expenses.
34. The expression, "Too many corporate managers, auditors, and analysts are participants in a game of nods and winks" is attributable to: A. Barry Minkow B. Jerry Seinfeld C. Bernie Ebbers D. Arthur Levitt
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35. Which of the following is NOT an earnings management technique? A. Recording revenue the customer is obligated to pay B. Recording revenue when future services remain to be provided C. Recording sales that lack economic substance D. Including investment income or gains as part of revenue
36. Which of the following is NOT an aggressive accounting practice? A. Non-GAAP method of capitalization interest on landfill development costs. B. Failure to properly accrue for tax and self-insurance expense. C. Under the accrual method, companies charge warranty costs to operating expense in the year of sale. D. Refusal to write-off permitting and/or project costs on impaired or abandoned landfills.
37. Which of the following is NOT addressed in the Waste Management's case? A. The misstatements represented 10% of pre-tax income, which was not considered material. B. The company employed aggressive accounting practices to enhance its earnings. C. The company used the gain to offset unrelated operating expenses which was not in conformity with GAAP. D. The company's auditor, Arthur Andersen, had engaged in improper professional conduct.
38. In the Xerox case, who was Xerox's auditor? A. Ernst & Young B. Deloitte & Touche C. Arthur Andersen D. KPMG
39. Congress passed the "Sarbanes-Oxley Act" on July 30, 2002. Which of the following is NOT true? A. All reporting companies are required to include in their annual reports a report of management on the company's internal control over financial reporting. B. New audit standards include a prohibition against independent auditors providing many non-audit services and mandatory audit partner rotation. C. Only U.S. companies are subject to the disclosure requirements of the Act. D. The presentation of pro forma information is now required.
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40. Which of the statement regarding PCAOB is NOT true? A. PCAOB stands for Public Company Accounting Oversight Board. B. PCAOB assumes the peer review function over registered CPA firms. C. PCAOB was established before the accounting scandal of Enron. D. PCAOB protects the public interest by oversight of independent audits.
41. "Earnings management either ignores or does not consider the rights of the investors and creditors to receive accurate, reliable and transparent financial statements." This statement is from: A. A virtue perspective B. A utilitarian perspective C. A rights perspective D. A materiality perspective
42. Which of the following is NOT McKee's explanation of "earnings management"? A. A smooth net income by choice does not reflect what investors and creditors need or want to know since it masks true performance. B. It creates a more stable and predictable earnings stream by smoothing net income. C. It is a reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results. D. Earnings management reflects a conscious choice by management to smooth earnings over time and it does not include devices designed to "cook the books."
43. Who identifies seven common financial shenanigans? A. Schipper B. Schilit C. Levitt D. McKee
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44. In the Xerox case, the leases Xerox had signed met the criteria under SFAS No. 13 to be accounted for as: A. Capital leases B. Operating leases C. Bargain purchase option leases D. Sales-type leases
45. Which of the following is NOT a motivation to manage earnings in the Lucent Technology case? A. Realize revenue B. Meet predictions of outside securities analysts C. Meet internal sales target D. Obtain sales bonus
46. The main accounting issues in the Nortel Networks case were: A. Premature revenue recognition and hidden cash reserves B. Capitalization of operating expenses and hidden cash reserves C. Premature revenue recognition and off-balance-sheet entities D. Capitalization of operating expenses and off-balance-sheet entities
47. The swap transactions used in the Solutions Network case to manage earnings can best be described as: A. Going to a swap meet and capitalizing purchases instead of expensing them immediately against swap revenue B. Recording revenue on software systems transactions in an earlier period than when obligated to buy the same in a later period C. Using a cookie jar reserve to delay the recording of revenue into a later period D. Recording as operating revenue on onetime gains from the sale of underperforming assets
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48. The accounting issue in the Cubbies Cable case with respect to cable installations costs is closest to the accounting issue in which case? A. Enron B. Gemstar TV Guide C. Xerox D. WorldCom
49. The element of the fraud triangle most directly dealt with in the Excello Telecommunications case is: A. Pressure/Incentives B. Opportunity C. Rationalization D. Materiality
50. The accounting rule for deferring profit on a sale-leaseback agreement such as the one dealt with in the Florida Transportation case can best be described as: A. The seller-lessee can defer profit on a sale-leaseback transaction if the seller gives up substantially all of the use of the property through the leaseback. B. The seller-lessee can defer profit on a sale-leaseback transaction if the seller retains substantially all of the use of the property through the leaseback. C. Profit can be deferred if the upfront costs exceed future revenues. D. Profit can be deferred if initial revenue exceeds future costs.
51. In the Sweat Hog Construction case, the company tried to manipulate earnings through the use of which accounting technique? A. Cookie jar reserves B. Lease capitalization C. Percentage of completion method D. The Big Bath Theory
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52. Which of the following was not an accounting issue in the Sunbeam case? A. Cookie jar reserves B. Channel stuffing C. Bill and hold sales D. Swap transactions
53. The legal issue in the Altris Software v PricewaterhouseCoopers case that failed to be proved by the plaintiffs was: A. Privity B. Ordinary negligence C. Scienter D. Due care
54. The legal issue in the CellCyte Genetics Corporation case was: A. Making false and misleading statements in several SEC filings B. Making false and misleading statements in a court trial C. Privity D. Scienter
55. The former CEO of Vivendi Universal, Jean-Marie Messier, used as his defense in the case that: A. His actions were protected by attorney-client privilege B. While some of his actions may have turned out to be wrong, there never was an intent to defraud C. While some of his actions may have turned out to be wrong, he did the best that he could to save the company from certain bankruptcy D. He adhere to the business judgment rule and met his fiduciary obligations
Essay Questions
56. Explain when earnings management may be an ethical practice. Answers will vary
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57. Discuss all the factors an auditor should consider in making a materiality judgment. Answers will vary
58. Many of the cases discussed in the chapter address the issue of swap transactions. What is a swap transaction? What criteria should be used to determine how and when to record revenue on swap transactions? Describe the facts of any one case in the book with respect to proper recording for revenue in swap transactions. Answers will vary
59. The amount and size of earnings restatements were relatively high in the early and mid2000s. Explain the reasons that these instances were frequent and amounts high during that period of time. Answers will vary
60. Explain each of the seven financial shenanigans described by Schilit. Be sure to give an example of each one. Answers will vary
61. Select either the Xerox or Lucent frauds described in the chapter and explain the accounting techniques used to commit fraud. Answers will vary
62. Use the fraud triangle to evaluate the actions by those in top management at Enron as the accounting fraud unfolded. Answers will vary
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63. Evaluate the ethics at Enron and by those in top management with respect to its operations and accounting and financial reporting techniques. Answers will vary
64. The quality of financial reporting is an important issue in the chapter. Explain how and why the quality of financial reporting is an underlying issue in the frauds discussed in the chapter.
Answers will vary
65. Assume you were in Sherron Watkins' position and you informed Ken Lay that the company might implode as a result of the accounting scandal. After an investigation by the lawyers who said there was nothing to worry about, Lay told you he would take no steps to act on your concerns. Use the relevant elements of the decision making model described in chapter 2 including stakeholder and ethical considerations and decide on a course of action for Watkins. Answers will vary
66. Steve is quickly moving up in the accounting department of RAC Inc. It is yearend; he has just received news that the estimates of the estimated useful life and salvage values were wrong and must be changed. Of course, that changes the depreciation expense and accumulated depreciation. Steve calls his wife to explain why he will be late again. Now is he is pondering on a comment his wife made. She said "I'm no accountant; but after four years, you would think that the company could get done how its estimates affect expenses and those other accounts." What might the company be doing and what should Steve do from an ethical reasoning view?
The Company is probably managing earnings. Steve can reason from rights, deontology, utilitarianism, or virtue theories. Steve must choose from refusing to assist the company in managing earnings (and probably lose his job) and blowing the whistle. If the Company has a Hotline, Steve may get to choose to be anonymous. Steve may also want to discuss the matter with the audit committee.
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Chapter 08 International Financial Reporting: Ethics and Corporate Governance Considerations

1. A common set of accounting standards on an international level can help to achieve each of the following except for: A. Facilitate the understandability of financial reports prepared outside the home country of a potential investor. B. Provide a foundation for professional judgment and support the implementation of international financial reporting standards (IFRS). C. Provide a foundation for professional judgment and support the implementation of international standards of Auditing (ISAs). D. Facilitate the enforcement of IFRS and (ISAs).
2. IFRS tends to be more ____________ than U.S. GAAP. A. rules-based B. principles based C. consistent D. accurate
3. One problem of a more principles-based system that was pointed out in an SEC study is that they: A. Tend to be rules-based than objectives-oriented standards B. May present enforcement problems C. Use bright-line tests D. All of the above
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4. The SEC study of a principles-based system identifies each of the following characteristics that should guide standards setting except for: A. Be based on an improved and consistently applied conceptual framework B. Clearly state the accounting objective of the standard C. Minimize exceptions from the standards D. Minimize the detail and structure so that the standard can be operationalized and applied on a consistent basis
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5. The SEC roadmap refers to: A. A map of the highways and freeways to take to drive from Texas to California. B. A series of steps to be taken by FASB to adopt IFRS in the U.S. C. A timetable for adoption of IFRS in the U.S. D. A series of steps to be taken by the SEC to adopt IFRS in the U.S.
6. Given that IFRS is not currently required in the U.S., foreign companies that list their stock on the New York Stock Exchange must: A. Reconcile the financial statements in their home country GAAP to U.S. GAAP B. Use IFRS in their financial statements C. Either reconcile their statements to U.S. GAAP or use IFRS D. Use their home country GAAP in their financial statements listed on the NYSE
7. The concept of "improve and adopt" refers to: A. The adoption of IFRS in the U.S. B. The use of home country standards in the U.S. C. The translation of foreign-based currency statements to U.S. dollars D. The convergence of IFRS with GAAP
8. One benefit that may derive from the Memorandum of Understanding is that: A. The International Organization of Securities Commissions (IOSCO) can facilitate the development of IFRS B. IOSCO can facilitate the cross-border exchange of information to facilitate compliance with IFRS C. IOSCO can facilitate the cross-border exchange of information to facilitate compliance with securities laws and regulations D. All of the above
9. The number of countries that are expected to adopt IFRS as their home country standards by 2011 is: A. 117 B. 150 C. 167 D. 200
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10. The Norwalk agreement refers to: A. The commitment of the U.S. and European Union to adopt one set of accounting standards B. The commitment of FASB and the International Accounting Standards Board (IASB) to adopt one set of accounting standards C. The commitment of FASB and IASB to the convergence of U.S. GAAP and international accounting standards D. The agreement that ended World War II
11. One concern with U.S. GAAP identified by Schipper is: A. The principles that underlie U.S. GAAP can become rules-based exercises during implementation B. The principles that underlie U.S. GAAP do not provide any implementation guidance C. The rules that are part of the U.S. system are not based on an underlying conceptual framework D. The rules that are part of the U.S. system are not based on any principles
12. The relatively more principles-based IFRS standards requires each of the following except for: A. Professional judgment based on the substance over form concept B. Professional judgment in applying the true and fair view override C. Professional judgment at both the transaction and financial statement levels D. Professional judgment in applying the present fairly concept
13. The IASB Framework for the Preparation and Presentation of Financial Statements: A. Dictates the standards to be followed in preparing financial statements under IFRS B. Requires an entity to use its judgment in developing and applying and accounting policy that results in information that is relevant and reliable C. Serves as a guide to resolving accounting issues that are not addressed directly in a standard D. All of the above
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14. The reason some people are concerned about the possibility for earnings management under IFRS is: A. The principles-based system might lead preparers of financial statements to try and justify earnings by applying a substance over form concept. B. The principles-based system might lead preparers of financial statements to try and justify specific accounting outcome based on commercial drivers. C. It is more difficult to make materiality judgments. D. It is more difficult to implement a set of generally accepted accounting and financial reporting standards.
15. The FASB and IASB joint conceptual framework project has as its objective: A. The developing of a single set of generally accepted accounting and financial reporting standards. B. The developing of a sound foundation for developing future accounting standards. C. The replacement of existing FASB and IASB separate conceptual framework projects. D. The replacement of a rules-bases system with a principles-based approach to accounting and financial reporting standards.
16. The FASB and IASB joint conceptual framework differs from the U.S. conceptual framework in that: A. The joint conceptual framework identifies the concept of representational faithfulness as an element of reliability in determining useful information B. The joint conceptual framework identifies the concept of representational faithfulness as an element of relevance in determining useful information C. The joint conceptual framework excludes representational faithfulness from the determination of useful information D. The joint conceptual framework considers representational faithfulness as a foundational element of useful information
17. Lease standards in the U.S. can be manipulated to achieve the desired goal of: A. Capitalizing lease payments at their present values to record an asset instead of an expense B. Capitalizing lease payments at their present values to record an expense instead of an asset C. Emphasizing form over substance D. All of the above
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18. The rules under IFRS for property, plant, and equipment differ from U.S. GAAP because: A. U.S. GAAP allows for the revaluation of property, plant, and equipment B. IFRS allows for the revaluation of property, plant, and equipment C. U.S. GAAP permits the LIFO method of valuation D. IFRS prohibits accelerated methods of depreciation
19. In the U.S., the word "reserve" always means: A. Impairment B. A market value adjustment C. Provision D. A depreciation write-down
20. The difference between provisions and reserves can best be characterized as: A. Provisions are liabilities recognized by charges against profit whereas a reserve is an element of shareholders' equity B. Provisions are an element of shareholders' equity whereas a reserve is a liability recognized by charges against profit C. Provisions reduce assets to net realizable value whereas reserves are liabilities recognized by charges against profit D. Reserves always reduce profits
21. A "secret" or "hidden" reserve can occur when a company does one or more of the following except for: A. Fails to recognize an asset in its balance sheet B. Deliberately measures an asset at an unreasonably low value C. Sets up unnecessarily high provisions D. Sets up unnecessarily low provisions
22. Each of the following can be a motivation to record a secret reserve except for: A. Understate net assets and equity B. Overstate net assets and equity C. Record amounts in the name of prudence D. Record amounts to get tax deductions
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23. The provisions footnote in the Siemens Annual Report presented in the chapter requires recognition in the balance sheet when each of the following criteria is met except for: A. The company has a present legal or constructive obligation as a result of a past event B. It is probable that an outflow of economic benefits will be required to settle the obligation C. It is reasonably possible that an outflow of economic benefits will be required to settle the obligation D. A reliable estimate can be made of the amount of the obligation
24. The term "small and medium-sized" entities in the IASB's pronouncement on IFRS for Small and Medium-sized Entities (SMEs) defines SMEs as: A. Those entities with public accountability that publish general purpose financial statements B. Those entities without public accountability that publish general purpose financial statements C. Those entities that use IFRS in their general purpose financial statements D. Those entities that use U.S. GAAP in their general purpose financial statements
25. Each of the following is an example of the difference between application of full-IFRS and IFRS for SMEs except for: A. Cost or revaluation method for full-IFRS; cost method only for IFRS for SMEs B. Revaluation method for full-IFRS; cost or revaluation for IFRS for SMEs C. Expensing of all research and development costs as incurred for full-IFRS and capitalizing and amortizing development costs that meet specific criteria; expensing of all research and development costs as incurred for SMEs D. Capitalizing borrowing costs if certain criteria are met for full-IFRS; expensing all borrowing costs for IFRS for SMEs
26. Accounting policies that should be used in the first period of IFRS adoption should be: A. Those that conform to the home country standards B. Those that conform to IFRS in effect in the subsequent reporting period C. Those that conform to IFRS in effect at the current reporting date D. Any of the above can be used based on the judgment of the accountants
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27. One feature of corporate governance in Germany that makes it stand out when compared to the U.S. is: A. A separate audit committee and a board of directors B. A unitary board of directors system C. A dual board of directors system D. Compliance with the Sarbanes-Oxley Act
28. Under a dual board system, the board that carries out management directives for the benefit of various stakeholder groups is: A. The Management Board B. The Supervisory Board C. The Board of Governors D. The Board of Trustees
29. The primary role of the Supervisory Board is to: A. Manage the enterprise for the benefit of various stakeholder groups B. Work with the auditors in their review of financial statements C. Work with the managing board in running day-to-day operations D. Oversee and advise the Managing Board on policy matters
30. A distinguishing characteristic(s) of corporate governance in China is the importance of: A. State investors in Chinese entities B. Family ownership of Chinese entities C. Blockholders of Chinese entities D. All of the above
31. The comply or explain principle refers to: A. Certification of financial statements by CEOs and CFOs B. Explain any gaps between existing corporate governance practices and recommendations by authoritative bodies/pronouncements C. Explain any gaps between existing corporate governance practices and IFRS requirements D. Certification of corporate governance practices by CEOS and CFOs
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32. A distinguishing characteristic(s) of corporate governance in India is the importance of: A. Some government ownership of Indian entities B. Family ownership of Indian entities C. A large industrial group may own shares in an Indian entity D. All of the above
33. The Tata Group's code of ethics contains each of the following provisions except for: A. Relatively minor gifts can be made if normal and customary B. Conflicts of interest should be avoided and, if they exist, they should be reported to the CEO C. The code prohibits the use of confidential information without the explicit approval of management D. Insider information can be used as long as it is approved by management
34. The OECD Principles of Corporate Governance contain each of the following recommendations except for: A. Promote transparent and efficient markets B. Adoption of the unitary model of board of directors C. Allowing shareholders the right of redress for violations of their rights D. Timely and accurate disclosure of all material matters regarding the corporation and its financial situation
35. A member body of the International Federation of Accountants (IFAC) should follow the provisions in the Code of Ethics for Professional Accountants (IFAC Code) when each of the following exists except for: A. A member body of IFAC applies less stringent standards than those stated in the IFAC Code B. The member body is prohibited by law or regulation from complying with certain parts of the Code and complies with all other parts of the code C. The member body is prohibited by law or regulation from complying with certain parts of the Code and does not comply with all other parts of the code D. All of the above
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36. International Standards of Auditing (ISAs) should be used by members of IFAC unless: A. They conflict with the auditing standards in the home country B. Local laws or regulations differ from or conflict with, the standards of the International Auditing and Assurances Board (IAASB) C. They conflict with IFRS D. Local laws or regulations are the same as ISAs
37. Which of the following statements is most accurate with respect to the similarity between ISAs and U.S. GAAS? A. ISAs are the same as U.S. GAAS B. ISAs are quite similar to U.S. GAAS C. ISAs and U.S. GAAS differ significantly D. ISAs have replaced U.S. GAAS
38. The auditor evaluates audit evidence to do which of the following? A. To obtain reasonable assurance about whether the financial statements give a true or fair view or are presented fairly B. To obtain reasonable assurance whether the financial statements are prepared in accordance with GAAP in the U.S. C. To obtain reasonable assurance IFRS internationally D. All of the above
39. Differences between international audit report language and language in U.S. audit reports include all of the following except for: A. The report states in the scope paragraph that the selection of audit procedures requires the exercise of professional judgment including the assessment of the risks of material misstatements, whether due to error or fraud B. The opinion paragraph can be couched in either the words present fairly or a true and fair view C. A separate paragraph is provided for those entities required by law to report on compliance with legal and regulatory requirements D. The report acknowledges management's responsibility for the financial statements
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40. One way to characterize the term "true and fair view" is that: A. It is used to determine which international auditing standards should be used. B. It is used to assess whether the entity has met the comply or explain provisions in corporate governance codes. C. It is a governing criterion by which financial statements are to be judged. D. All of the above.
41. In the SEC v. Siemens Aktiengesellschaft case, each of the following charges were made against the company's Managing Board except for: A. The Board failed to ensure that Siemens met the U.S. regulatory and anti-bribery provisions of the Foreign Corrupt Practices Act B. The Board failed to meet its obligations with respect to compliance procedures at Siemens C. The Board failed to adequately supervise the auditors of Siemens D. The Board created a corporate culture that contributed toward tolerating and even rewarding bribery
42. The trigger event that led to the disclosure of the scandal at Parmalat was: A. Almost 4 billion of company funds that were supposed to be held in an account at Bank of America did not exist. B. The company stuffed the channels with product that it eventually was not purchased by customers. C. Parmalat officers violated the Foreign Corrupt Practices Act. D. The company sold sour milk.
43. The case that deals with conflicts between management and the board of directors and the role of family members in various business entities is: A. Parmalat B. Satyam C. Bat-A-Bing Construction D. Enron
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44. The primary accounting issue in the Royal Dutch Shell case is: A. The failure of the company to properly account for oil exploration costs B. The failure of the company to adhere to provisions of the Foreign Corrupt Practices Act C. The failure of the company to adhere to SEC rules and the accounting for proved reserves D. All of the above
45. The Bat-A-Bing case deals with which of the following accounting issues. A. Proved reserves B. Unapproved claims C. Contractual allowances D. Franchise revenue
Essay Questions
46. From a U.S. perspective, are there any concerns that regulators and standard setters should have about moving towards the adoption of IFRS in the U.S.? Why are they concerns?
47. Explain why you think the authors of studies cited in the text were concerned about whether a principles-based approach to standard setting might lead to earnings management.
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48. Explain the role of ethics and virtue-based principles in evaluating whether financial information faithfully represents economic phenomena.
49. Full-IFRS permits the revaluation of property, plant, and equipment while IFRS for SMEs does not. In the U.S., the cost method (less amortization) must be used. From a conceptual framework perspective, is it possible to justify the use of the revaluation technique? Be sure to describe relevant concepts in answering this question. Why do you think IFRS for SMEs does not permit revaluation while full-IFRS does? Are these inconsistent requirements?
50. Compare and contrast corporate governance provisions in the U.S. with those in Germany? Where differences exist, evaluate whether you think the U.S. system is preferable or the German system.
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51. In China and India different ownership groups often play a role much more important than these groups play in the U.S. Describe the different ownership patterns in China and India. Why do you think these groups have a larger role to play? Are there any concerns about the fact that they play such a larger role?
52. Why is it important to have a Global Code of Ethics for professional accountants around the world? That is, what is such a code trying to accomplish?
53. It has been said that there is more conformity in international auditing standards around the world than on international financial reporting standards. Why do you think this may be the case?
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54. In some countries the laws and regulations play a much bigger role in establishing accounting and financial reporting standards than in the U.S. Discuss the difficulties that may arise on an international level in the process of developing IFRS given the varying influences of governments and regulators in the national standard setting process.
55. Consider the discussion in the chapter about establishing one set of accounting standards and comment on whether you think there should be one set of educational standards for accounting students at educational institutions in countries that comply with IFRS. Should there be a uniform CPA (Chartered Accountants) Exam for all such students? Why or why not?
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Chapter 08 International Financial Reporting: Ethics and Corporate Governance Considerations Answer Key
1. A common set of accounting standards on an international level can help to achieve each of the following except for: A. Facilitate the understandability of financial reports prepared outside the home country of a potential investor. B. Provide a foundation for professional judgment and support the implementation of international financial reporting standards (IFRS). C. Provide a foundation for professional judgment and support the implementation of international standards of Auditing (ISAs). D. Facilitate the enforcement of IFRS and (ISAs).
2. IFRS tends to be more ____________ than U.S. GAAP. A. rules-based B. principles based C. consistent D. accurate
3. One problem of a more principles-based system that was pointed out in an SEC study is that they: A. Tend to be rules-based than objectives-oriented standards B. May present enforcement problems C. Use bright-line tests D. All of the above
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4. The SEC study of a principles-based system identifies each of the following characteristics that should guide standards setting except for: A. Be based on an improved and consistently applied conceptual framework B. Clearly state the accounting objective of the standard C. Minimize exceptions from the standards D. Minimize the detail and structure so that the standard can be operationalized and applied on a consistent basis
5. The SEC roadmap refers to: A. A map of the highways and freeways to take to drive from Texas to California. B. A series of steps to be taken by FASB to adopt IFRS in the U.S. C. A timetable for adoption of IFRS in the U.S. D. A series of steps to be taken by the SEC to adopt IFRS in the U.S.
6. Given that IFRS is not currently required in the U.S., foreign companies that list their stock on the New York Stock Exchange must: A. Reconcile the financial statements in their home country GAAP to U.S. GAAP B. Use IFRS in their financial statements C. Either reconcile their statements to U.S. GAAP or use IFRS D. Use their home country GAAP in their financial statements listed on the NYSE
7. The concept of "improve and adopt" refers to: A. The adoption of IFRS in the U.S. B. The use of home country standards in the U.S. C. The translation of foreign-based currency statements to U.S. dollars D. The convergence of IFRS with GAAP
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8. One benefit that may derive from the Memorandum of Understanding is that: A. The International Organization of Securities Commissions (IOSCO) can facilitate the development of IFRS B. IOSCO can facilitate the cross-border exchange of information to facilitate compliance with IFRS C. IOSCO can facilitate the cross-border exchange of information to facilitate compliance with securities laws and regulations D. All of the above
9. The number of countries that are expected to adopt IFRS as their home country standards by 2011 is: A. 117 B. 150 C. 167 D. 200
10. The Norwalk agreement refers to: A. The commitment of the U.S. and European Union to adopt one set of accounting standards B. The commitment of FASB and the International Accounting Standards Board (IASB) to adopt one set of accounting standards C. The commitment of FASB and IASB to the convergence of U.S. GAAP and international accounting standards D. The agreement that ended World War II
11. One concern with U.S. GAAP identified by Schipper is: A. The principles that underlie U.S. GAAP can become rules-based exercises during implementation B. The principles that underlie U.S. GAAP do not provide any implementation guidance C. The rules that are part of the U.S. system are not based on an underlying conceptual framework D. The rules that are part of the U.S. system are not based on any principles
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12. The relatively more principles-based IFRS standards requires each of the following except for: A. Professional judgment based on the substance over form concept B. Professional judgment in applying the true and fair view override C. Professional judgment at both the transaction and financial statement levels D. Professional judgment in applying the present fairly concept
13. The IASB Framework for the Preparation and Presentation of Financial Statements: A. Dictates the standards to be followed in preparing financial statements under IFRS B. Requires an entity to use its judgment in developing and applying and accounting policy that results in information that is relevant and reliable C. Serves as a guide to resolving accounting issues that are not addressed directly in a standard D. All of the above
14. The reason some people are concerned about the possibility for earnings management under IFRS is: A. The principles-based system might lead preparers of financial statements to try and justify earnings by applying a substance over form concept. B. The principles-based system might lead preparers of financial statements to try and justify specific accounting outcome based on commercial drivers. C. It is more difficult to make materiality judgments. D. It is more difficult to implement a set of generally accepted accounting and financial reporting standards.
15. The FASB and IASB joint conceptual framework project has as its objective: A. The developing of a single set of generally accepted accounting and financial reporting standards. B. The developing of a sound foundation for developing future accounting standards. C. The replacement of existing FASB and IASB separate conceptual framework projects. D. The replacement of a rules-bases system with a principles-based approach to accounting and financial reporting standards.
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16. The FASB and IASB joint conceptual framework differs from the U.S. conceptual framework in that: A. The joint conceptual framework identifies the concept of representational faithfulness as an element of reliability in determining useful information B. The joint conceptual framework identifies the concept of representational faithfulness as an element of relevance in determining useful information C. The joint conceptual framework excludes representational faithfulness from the determination of useful information D. The joint conceptual framework considers representational faithfulness as a foundational element of useful information
17. Lease standards in the U.S. can be manipulated to achieve the desired goal of: A. Capitalizing lease payments at their present values to record an asset instead of an expense B. Capitalizing lease payments at their present values to record an expense instead of an asset C. Emphasizing form over substance D. All of the above
18. The rules under IFRS for property, plant, and equipment differ from U.S. GAAP because: A. U.S. GAAP allows for the revaluation of property, plant, and equipment B. IFRS allows for the revaluation of property, plant, and equipment C. U.S. GAAP permits the LIFO method of valuation D. IFRS prohibits accelerated methods of depreciation
19. In the U.S., the word "reserve" always means: A. Impairment B. A market value adjustment C. Provision D. A depreciation write-down
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20. The difference between provisions and reserves can best be characterized as: A. Provisions are liabilities recognized by charges against profit whereas a reserve is an element of shareholders' equity B. Provisions are an element of shareholders' equity whereas a reserve is a liability recognized by charges against profit C. Provisions reduce assets to net realizable value whereas reserves are liabilities recognized by charges against profit D. Reserves always reduce profits
21. A "secret" or "hidden" reserve can occur when a company does one or more of the following except for: A. Fails to recognize an asset in its balance sheet B. Deliberately measures an asset at an unreasonably low value C. Sets up unnecessarily high provisions D. Sets up unnecessarily low provisions
22. Each of the following can be a motivation to record a secret reserve except for: A. Understate net assets and equity B. Overstate net assets and equity C. Record amounts in the name of prudence D. Record amounts to get tax deductions
23. The provisions footnote in the Siemens Annual Report presented in the chapter requires recognition in the balance sheet when each of the following criteria is met except for: A. The company has a present legal or constructive obligation as a result of a past event B. It is probable that an outflow of economic benefits will be required to settle the obligation C. It is reasonably possible that an outflow of economic benefits will be required to settle the obligation D. A reliable estimate can be made of the amount of the obligation
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24. The term "small and medium-sized" entities in the IASB's pronouncement on IFRS for Small and Medium-sized Entities (SMEs) defines SMEs as: A. Those entities with public accountability that publish general purpose financial statements B. Those entities without public accountability that publish general purpose financial statements C. Those entities that use IFRS in their general purpose financial statements D. Those entities that use U.S. GAAP in their general purpose financial statements
25. Each of the following is an example of the difference between application of full-IFRS and IFRS for SMEs except for: A. Cost or revaluation method for full-IFRS; cost method only for IFRS for SMEs B. Revaluation method for full-IFRS; cost or revaluation for IFRS for SMEs C. Expensing of all research and development costs as incurred for full-IFRS and capitalizing and amortizing development costs that meet specific criteria; expensing of all research and development costs as incurred for SMEs D. Capitalizing borrowing costs if certain criteria are met for full-IFRS; expensing all borrowing costs for IFRS for SMEs
26. Accounting policies that should be used in the first period of IFRS adoption should be: A. Those that conform to the home country standards B. Those that conform to IFRS in effect in the subsequent reporting period C. Those that conform to IFRS in effect at the current reporting date D. Any of the above can be used based on the judgment of the accountants
27. One feature of corporate governance in Germany that makes it stand out when compared to the U.S. is: A. A separate audit committee and a board of directors B. A unitary board of directors system C. A dual board of directors system D. Compliance with the Sarbanes-Oxley Act
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28. Under a dual board system, the board that carries out management directives for the benefit of various stakeholder groups is: A. The Management Board B. The Supervisory Board C. The Board of Governors D. The Board of Trustees
29. The primary role of the Supervisory Board is to: A. Manage the enterprise for the benefit of various stakeholder groups B. Work with the auditors in their review of financial statements C. Work with the managing board in running day-to-day operations D. Oversee and advise the Managing Board on policy matters
30. A distinguishing characteristic(s) of corporate governance in China is the importance of: A. State investors in Chinese entities B. Family ownership of Chinese entities C. Blockholders of Chinese entities D. All of the above
31. The comply or explain principle refers to: A. Certification of financial statements by CEOs and CFOs B. Explain any gaps between existing corporate governance practices and recommendations by authoritative bodies/pronouncements C. Explain any gaps between existing corporate governance practices and IFRS requirements D. Certification of corporate governance practices by CEOS and CFOs
32. A distinguishing characteristic(s) of corporate governance in India is the importance of: A. Some government ownership of Indian entities B. Family ownership of Indian entities C. A large industrial group may own shares in an Indian entity D. All of the above
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33. The Tata Group's code of ethics contains each of the following provisions except for: A. Relatively minor gifts can be made if normal and customary B. Conflicts of interest should be avoided and, if they exist, they should be reported to the CEO C. The code prohibits the use of confidential information without the explicit approval of management D. Insider information can be used as long as it is approved by management
34. The OECD Principles of Corporate Governance contain each of the following recommendations except for: A. Promote transparent and efficient markets B. Adoption of the unitary model of board of directors C. Allowing shareholders the right of redress for violations of their rights D. Timely and accurate disclosure of all material matters regarding the corporation and its financial situation
35. A member body of the International Federation of Accountants (IFAC) should follow the provisions in the Code of Ethics for Professional Accountants (IFAC Code) when each of the following exists except for: A. A member body of IFAC applies less stringent standards than those stated in the IFAC Code B. The member body is prohibited by law or regulation from complying with certain parts of the Code and complies with all other parts of the code C. The member body is prohibited by law or regulation from complying with certain parts of the Code and does not comply with all other parts of the code D. All of the above
36. International Standards of Auditing (ISAs) should be used by members of IFAC unless: A. They conflict with the auditing standards in the home country B. Local laws or regulations differ from or conflict with, the standards of the International Auditing and Assurances Board (IAASB) C. They conflict with IFRS D. Local laws or regulations are the same as ISAs
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37. Which of the following statements is most accurate with respect to the similarity between ISAs and U.S. GAAS? A. ISAs are the same as U.S. GAAS B. ISAs are quite similar to U.S. GAAS C. ISAs and U.S. GAAS differ significantly D. ISAs have replaced U.S. GAAS
38. The auditor evaluates audit evidence to do which of the following? A. To obtain reasonable assurance about whether the financial statements give a true or fair view or are presented fairly B. To obtain reasonable assurance whether the financial statements are prepared in accordance with GAAP in the U.S. C. To obtain reasonable assurance IFRS internationally D. All of the above
39. Differences between international audit report language and language in U.S. audit reports include all of the following except for: A. The report states in the scope paragraph that the selection of audit procedures requires the exercise of professional judgment including the assessment of the risks of material misstatements, whether due to error or fraud B. The opinion paragraph can be couched in either the words present fairly or a true and fair view C. A separate paragraph is provided for those entities required by law to report on compliance with legal and regulatory requirements D. The report acknowledges management's responsibility for the financial statements
40. One way to characterize the term "true and fair view is that: A. It is used to determine which international auditing standards should be used. B. It is used to assess whether the entity has met the comply or explain provisions in corporate governance codes. C. It is a governing criterion by which financial statements are to be judged. D. All of the above.
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41. In the SEC v. Siemens Aktiengesellschaft case, each of the following charges were made against the company's Managing Board except for: A. The Board failed to ensure that Siemens met the U.S. regulatory and anti-bribery provisions of the Foreign Corrupt Practices Act B. The Board failed to meet its obligations with respect to compliance procedures at Siemens C. The Board failed to adequately supervise the auditors of Siemens D. The Board created a corporate culture that contributed toward tolerating and even rewarding bribery
42. The trigger event that led to the disclosure of the scandal at Parmalat was: A. Almost 4 billion of company funds that were supposed to be held in an account at Bank of America did not exist. B. The company stuffed the channels with product that it eventually was not purchased by customers. C. Parmalat officers violated the Foreign Corrupt Practices Act. D. The company sold sour milk.
43. The case that deals with conflicts between management and the board of directors and the role of family members in various business entities is: A. Parmalat B. Satyam C. Bat-A-Bing Construction D. Enron
44. The primary accounting issue in the Royal Dutch Shell case is: A. The failure of the company to properly account for oil exploration costs B. The failure of the company to adhere to provisions of the Foreign Corrupt Practices Act C. The failure of the company to adhere to SEC rules and the accounting for proved reserves D. All of the above
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45. The Bat-A-Bing case deals with which of the following accounting issues. A. Proved reserves B. Unapproved claims C. Contractual allowances D. Franchise revenue
Essay Questions
46. From a U.S. perspective, are there any concerns that regulators and standard setters should have about moving towards the adoption of IFRS in the U.S.? Why are they concerns? Answers will vary
47. Explain why you think the authors of studies cited in the text were concerned about whether a principles-based approach to standard setting might lead to earnings management. Answers will vary
48. Explain the role of ethics and virtue-based principles in evaluating whether financial information faithfully represents economic phenomena. Answers will vary
49. Full-IFRS permits the revaluation of property, plant, and equipment while IFRS for SMEs does not. In the U.S., the cost method (less amortization) must be used. From a conceptual framework perspective, is it possible to justify the use of the revaluation technique? Be sure to describe relevant concepts in answering this question. Why do you think IFRS for SMEs does not permit revaluation while full-IFRS does? Are these inconsistent requirements? Answers will vary
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50. Compare and contrast corporate governance provisions in the U.S. with those in Germany? Where differences exist, evaluate whether you think the U.S. system is preferable or the German system. Answers will vary
51. In China and India different ownership groups often play a role much more important than these groups play in the U.S. Describe the different ownership patterns in China and India. Why do you think these groups have a larger role to play? Are there any concerns about the fact that they play such a larger role? Answers will vary
52. Why is it important to have a Global Code of Ethics for professional accountants around the world? That is, what is such a code trying to accomplish? Answers will vary
53. It has been said that there is more conformity in international auditing standards around the world than on international financial reporting standards. Why do you think this may be the case? Answers will vary
54. In some countries the laws and regulations play a much bigger role in establishing accounting and financial reporting standards than in the U.S. Discuss the difficulties that may arise on an international level in the process of developing IFRS given the varying influences of governments and regulators in the national standard setting process. Answers will vary
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55. Consider the discussion in the chapter about establishing one set of accounting standards and comment on whether you think there should be one set of educational standards for accounting students at educational institutions in countries that comply with IFRS. Should there be a uniform CPA (Chartered Accountants) Exam for all such students? Why or why not? Answers will vary
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Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 Audit Responsibilities and Accounting Fraud Answer Key

Multiple Choice Questions

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 06 Legal and Regulatory Obligations in an Ethical Framework

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05 - Audit Responsibilities and Accounting Fraud