Q6. Page observes in Best Made’s financial statements that for the past three years, the company has sold more inventory than it

    produced. Best Made is most likely attempting to manipulate its reported earnings by utilizing which of the following methods?

A)   Utilizing LIFO liquidations.

B)   Creating “cookie jar” reserves.

C)   Delaying expense recognition.

Q7. With regards to SAS No. 99 and the “fraud triangle”, which of the following statements regarding the conditions that may lead to

    fraudulent financial reporting is most accurate?

A)   An opportunity to commit financial statement fraud when there is a company mindset that fraudulent behavior is justified.

B)   There is often pressure to commit financial statement fraud when there is a weakness in the company’s internal control system.

C)   Both external and internal incentives and pressures are the motives that lead management to commit financial statement fraud.

Q8. The nature of a firm’s industry or operations can lead to the existence of opportunities to commit fraud. Which of the following

    risk factors are related to opportunities to commit fraud?

A)   Management being dominated by a single person or small group.

B)   Significant related party transactions, especially when those parties are audited by another firm.

C)   Ineffective oversight by the board of directors or audit committee.

Q9. Earlier this year, Barracuda Company issued 5,000 employee stock options. Recently, 2,000 options were exercised at a price

of $10 per share. To avoid dilution, Barracuda purchased 2,000 shares at an average price of $12 per share. Barracuda

reported both transactions as financing activities in its cash flow statement. For analytical purposes, what adjustment is

necessary to better reflect the substance of the stock repurchase?

     Operating cash flow          Financing cash flow

A)       Decrease $4,000     Increase $4,000

B)       Decrease $4,000     No adjustment

C)       No adjustment         Increase $4,000

Q10. Glenmark Blades and Propellers has set up special purpose entities to handle its manufacturing. The company does not

     consolidate those entities. Glenmark is most likely obeying:

A)   neither the spirit of the law nor the letter of the law.

B)   the spirit of the law but not the letter of the law.

C)   the letter of the law but not the spirit of the law.

Q11. Samson Therapeutics records all leases as operating leases. The company most likely wanted to reduce:

A)   leverage.

B)   expenses.

C)   inventory.

Q12. Joe Carter, CFA, believes Triangle Equipment, a maker of large, specialized industrial equipment, has overstated the salvage

     value of its equipment. This would:

A)   overstate earnings.

B)   overstate liabilities.

C)   understate earnings.

Q6. Page observes in Best Made’s financial statements that for the past three years, the company has sold more inventory than it fficeffice" />

    produced. Best Made is most likely attempting to manipulate its reported earnings by utilizing which of the following methods?

A)   Utilizing LIFO liquidations.

B)   Creating “cookie jar” reserves.

C)   Delaying expense recognition.

Correct answer is A)

Under the LIFO inventory method, when a firm sells more inventory than it produces, it will in effect lower its cost of goods sold by matching current sales with older, lower cost inventory. The increased profit is not sustainable because the firm will eventually liquidate its entire inventory.

Q7. With regards to SAS No. 99 and the “fraud triangle”, which of the following statements regarding the conditions that may lead to

    fraudulent financial reporting is most accurate?

A)   An opportunity to commit financial statement fraud when there is a company mindset that fraudulent behavior is justified.

B)   There is often pressure to commit financial statement fraud when there is a weakness in the company’s internal control system.

C)   Both external and internal incentives and pressures are the motives that lead management to commit financial statement fraud.

Correct answer is C)

Incentive or pressure, opportunity and attitudes or rationalization are the three corners of the fraud triangle. Incentive or pressure can come from one of many sources, and is the motive that exists to commit fraud.

Q8. The nature of a firm’s industry or operations can lead to the existence of opportunities to commit fraud. Which of the following

    risk factors are related to opportunities to commit fraud?

A)   Management being dominated by a single person or small group.

B)   Significant related party transactions, especially when those parties are audited by another firm.

C)   Ineffective oversight by the board of directors or audit committee.

Correct answer is B)

The only risk factor that relates to a company’s industry or operations is the presence of a significant level of related party transactions. Both remaining risk factors are related to ineffective management monitoring or a complex or unstable organizational structure.

Q9. Earlier this year, Barracuda Company issued 5,000 employee stock options. Recently, 2,000 options were exercised at a price

of $10 per share. To avoid dilution, Barracuda purchased 2,000 shares at an average price of $12 per share. Barracuda

reported both transactions as financing activities in its cash flow statement. For analytical purposes, what adjustment is

necessary to better reflect the substance of the stock repurchase?

     Operating cash flow          Financing cash flow

A)       Decrease $4,000     Increase $4,000

B)       Decrease $4,000     No adjustment

C)       No adjustment         Increase $4,000

Correct answer is A)

Barracuda reported a $4,000 net outflow from financing activities [2,000 options × ($12 average market price – $10 exercise price)]. However, since the options are a form of compensation, the $4,000 outflow should be reclassified as an operating activity for analytical purposes. This is accomplished by increasing financing cash flow $4,000 and decreasing operating cash flow $4,000.

Q10. Glenmark Blades and Propellers has set up special purpose entities to handle its manufacturing. The company does not

     consolidate those entities. Glenmark is most likely obeying:

A)   neither the spirit of the law nor the letter of the law.

B)   the spirit of the law but not the letter of the law.

C)   the letter of the law but not the spirit of the law.

Correct answer is C)        

Rules regarding special purpose entities (SPE) are quite broad, leaving companies with substantial leeway in interpretation. Separating capital-intensive manufacturing operations from the parent company’s books could give Glenmark a more appealing debt or asset picture. While companies can often opt not to consolidate SPEs, the goal of such entities is not to allow a company to manipulate its financial ratios.

Q11. Samson Therapeutics records all leases as operating leases. The company most likely wanted to reduce:

A)   leverage.

B)   expenses.

C)   inventory.

Correct answer is A)

Capitalized leases are recorded on the balance sheet, and by recording all leases as operating leases, the company can reduce its leverage. Lease accounting has no effect on inventory, and operating leases will increase expenses, not reduce them.

Q12. Joe Carter, CFA, believes Triangle Equipment, a maker of large, specialized industrial equipment, has overstated the salvage

     value of its equipment. This would:

A)   overstate earnings.

B)   overstate liabilities.

C)   understate earnings.

Correct answer is A)

Overstating the salvage value reduces depreciation expense, which in turn increases earnings.