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Reading 28: Financial Reporting Quality: Red Flags and Accou

1.Based on her analysis of Maxwell Research’s internal operations and business climate, analyst Jane Kilgore is concerned about management’s opportunities to commit fraud. Which of the following characteristics should worry Kilgore least?

A)   More than half of Kilgore’s revenue is generated in emerging markets.

B)   Kilgore’s market penetration gives it the ability to dictate terms to vendors.

C)   More than a third of Kilgore’s total sales go to its own consolidated subsidiaries.

D)   Kilgore’s widely diversified business mix makes its accounting quite complicated.

2.Analyst Jane Kilgore is worried about the quality of Maxwell Research’s earnings for the following reasons:

§ Management turnover is high.

§ Technology systems are outdated.

§ The organizational structure is complex.

§ Maxwell uses the unit-of-production method.

Which of Kilgore’s concerns is least valid?

A)   Management turnover is high.

B)   Technology systems are outdated.

C)   The organizational structure is complex.

D)   Maxwell uses the unit-of-production method.

3.Jane Kilgore, a stock analyst, is concerned about Maxwell Research’s organizational structure. To investigate the stability of that structure, Kilgore would be best served by looking at:

A)   accounting-department turnover.

B)   bank accounts located in tax havens.

C)   the amount of judgment calls used in company accounting.

D)   management turnover.

4.Professor Paula King teaches accounting at South Central Coastal Idaho Polytechnic. In her lecture this morning, she passes out sheets containing facts about Consolidated Industries. From those fact sheets, she identifies four signs that could indicate financial fraud:

§ Executives have personally guaranteed some of the firm’s debt.

§ The company’s organizational chart is complex.

§ The company’s monopoly status allows it to charge any price it desires.

§ Turnover is high in the information-technology department.

After presenting those observations, King concludes that because of the four characteristics, executives at Consolidated have a greater opportunity than most to commit fraud. Student Mukesh Ghari believes one of King’s examples does not help her argument. Which of the four facts is least compelling in support of King’s argument?

A)   The company’s organizational chart is complex.

B)   Turnover is high in the information-technology department.

C)   The company’s monopoly status allows it to charge any price it desires.

D)   Executives have personally guaranteed some of the firm’s debt.

答案和详解如下:

1.Based on her analysis of Maxwell Research’s internal operations and business climate, analyst Jane Kilgore is concerned about management’s opportunities to commit fraud. Which of the following characteristics should worry Kilgore least?

A)   More than half of Kilgore’s revenue is generated in emerging markets.

B)   Kilgore’s market penetration gives it the ability to dictate terms to vendors.

C)   More than a third of Kilgore’s total sales go to its own consolidated subsidiaries.

D)   Kilgore’s widely diversified business mix makes its accounting quite complicated.

The correct answer was C)

High levels of related-party transactions are worrisome, particularly when those parties are not audited. But transactions within the company between subsidiaries consolidated in a company’s audited financial statements are neither unusual nor a particularly fertile ground for fraud. The other three characteristics are legitimate risk factors.

2.Analyst Jane Kilgore is worried about the quality of Maxwell Research’s earnings for the following reasons:

§ Management turnover is high.

§ Technology systems are outdated.

§ The organizational structure is complex.

§ Maxwell uses the unit-of-production method.

Which of Kilgore’s concerns is least valid?

A)   Management turnover is high.

B)   Technology systems are outdated.

C)   The organizational structure is complex.

D)   Maxwell uses the unit-of-production method.

The correct answer was D)

The unit-of-production method in and of itself is not a sign of poor earnings quality. The other three observations reflect signs of common risk factors for entities at which executives have the opportunity to commit fraud.

3.Jane Kilgore, a stock analyst, is concerned about Maxwell Research’s organizational structure. To investigate the stability of that structure, Kilgore would be best served by looking at:

A)   accounting-department turnover.

B)   bank accounts located in tax havens.

C)   the amount of judgment calls used in company accounting.

D)   management turnover.

The correct answer was D)

All of the factors listed above are of concern to an analyst looking at the possibility of fraudulent accounting. But to assess the stability of the organizational structure, the best option is a look at management turnover. High turnover rates in either the accounting or IT department may be indicative of deficient internal controls, but are too localized to be a true indicator of organizational stability. The use of tax havens and judgment calls in accounting are legitimate worries, but neither is likely to be a direct reflection of an unstable organizational structure, as much as poor operational policies.

4.Professor Paula King teaches accounting at South Central Coastal Idaho Polytechnic. In her lecture this morning, she passes out sheets containing facts about Consolidated Industries. From those fact sheets, she identifies four signs that could indicate financial fraud:

§ Executives have personally guaranteed some of the firm’s debt.

§ The company’s organizational chart is complex.

§ The company’s monopoly status allows it to charge any price it desires.

§ Turnover is high in the information-technology department.

After presenting those observations, King concludes that because of the four characteristics, executives at Consolidated have a greater opportunity than most to commit fraud. Student Mukesh Ghari believes one of King’s examples does not help her argument. Which of the four facts is least compelling in support of King’s argument?

A)   The company’s organizational chart is complex.

B)   Turnover is high in the information-technology department.

C)   The company’s monopoly status allows it to charge any price it desires.

D)   Executives have personally guaranteed some of the firm’s debt.

The correct answer was D)

Executive guarantees of debt represent an incentive to commit fraud, but not necessarily an enhanced opportunity to do so. The other three examples are all legitimate risk factors related to opportunities that can lead to fraudulent accounting. Fraud is easier in complex organizations. Computers are important to financial reporting, and high turnover in that department could be sign of disorganization or dissatisfaction with technical systems. Outdated or badly designed computer systems make it easier to commit fraud. In addition, the company’s pricing power would make it much easier to conduct transactions that are not at arm’s length.

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