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Reading 26: Evaluating Financial Reporting Quality LOSg~

 

Q7. 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 a third of Maxwell’s total sales go to its own consolidated subsidiaries.

B)   More than half of Maxwell’s revenue is generated in emerging markets.

C)   Maxwell’s market penetration gives it the ability to dictate terms to vendors.

 

Q8. Katharine Walls, CFA, works as an auditor for Pindale Accounting. She is concerned about Smith Fabrics, a company she

audits. During her last visit to Smith Fabrics, the accounting director, Bob Fox, rudely ushered her into a tiny conference room

with no telephone or computer, and gave her no key to the main accounting office. She was given only three days to finish what

is normally a five-day job. Before he left Walls, Fox gave her a 150-page manual of Smith’s accounting policies for its various

overseas divisions. After she finished her audit, Walls prepared a report for Pindale’s executive director, recommending that the

firm drop Smith Fabrics as a client because she saw evidence of attitudes that could lead to fraudulent accounting. Walls cited

three of Fox’s actions in her report, most likely leaving out:

A)   her rude welcome.

B)   the policy manual.

C)   her isolation from the accounting department.

 

Q9. The Statement on Accounting Standards No. 99, Consideration of Fraud in a Financial Statement Audit, identified nine risk

    factors related to attitudes and rationalizations that can lead to fraudulent accounting. The risk factors include:

A)   management obsession with a rising stock price, failing to fix problems promptly, strained relationships with auditors.

B)   management obsession with a rising stock price, high management turnover, frequent use of materiality to justify leaving items off the books.

C)   commitments to third parties regarding operational results, high management turnover, obsession with minimizing taxes.

 

Q10. 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)   Executives have personally guaranteed some of the firm’s debt.

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

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

 

Q11. 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)   Maxwell uses the unit-of-production method.

B)   Management turnover is high.

C)   Technology systems are outdated.

 

Q12. Junior analyst Xander Marshall sends an e-mail to his boss, Janet Jacobs, CFA, suggesting that Peterson Novelties is

     manipulating its results to artificially inflate profits. He cites four reasons for his conclusion:

§            The LIFO reserve is declining. 

§            Earnings are much higher in the September quarter than in other quarters.

§            Many nonoperating and nonrecurring gains are being recorded as revenue.

§            Much of Peterson’s earnings come from equity investments not reflected on the cash-flow statement.

Jacobs is less concerned about Peterson’s earnings than Marshall is, though she does resolve to check out one of his concerns. Which of Marshall’s observations best supports his conclusion?

A)   Equity investment earnings not reflected on the cash-flow statement.

B)   Nonoperating and nonrecurring gains recorded as revenue.

C)   The declining LIFO reserve.

 

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