CFE Exam Quiz 59

According to the accounting model, to qualify as an asset, an item must:
(A) Be owned by the entity.
(B) Provide future benefits.

Assets consist of an entity’s owned net resources. Cash, receivables, inventory, property, and equipment, as well as intangible value items such as patents, licenses, and trademarks, are examples of assets.

Assets = Liabilities + Owners’ Equity

Therefore, the fraud examiner must understand the essential nature of financial transactions and their impact on records. Also, both financial terminology and accounting theory should be grasped by the fraud examiner.

Liabilities are the obligations of an entity or the claims of an outsider against the assets of a company. Examples of liabilities include payable accounts, notes payable, interest payable, and long-term debt.

Commonly, liabilities result from purchasing properties or incurring operating expenses.

Equity of owners is the contribution of owners of business plus cumulative income (revenues minus expenses).

According to the accounting model, owners’ equity is equal to assets minus liabilities.

outcome: Because both assets and liabilities are increasing by the same amount, the equation remains in balance.

Entries on an account’s left side are debits (dr), while entries on an account’s right side are credits (cr).

Debits increase asset and expense accounts, while credits decrease them.

Credits increase liability, owners’ equity, and revenue accounts while debits decrease them.

The term double-entry accounting is the correct term to be used to describe that every transaction recorded in the accounting records has both a debit and a credit.

The debit side of entry always equals the credit side of all three factors namely assets, liabilities and owner’s equity so that the accounting equation remains in balance.

The fraud investigator may then fairly conclude that by marking the misappropriated $5,000 as a legal expense, a criminal may have tried to hide the robbery.

One of the easiest ways to detect internal fraud is to discover concealment activities through a study of accounting records.

The flow of transactional information through the accounting records is listed below:
(A) Transaction occurs.
(B) Purchase orders, receipts, and other documents are created.
(C) The transaction is recorded in journals.
(D) Journals are posted to individual accounts.
(E) Financial statements are generated from account balances.

Each entry in a journal serves as a record of a particular transaction and forms an audit trail that can be traced later to gain an understanding of the operations of a company.

Things such as write-offs for depreciation and receivable accounts.

Journal entries that are not prompted by a transaction are called adjusting journal entries.

There are two primary methods of accounting: cash-basis and accrual-basis.

Cash-based accounting involves recording revenue and expenses based on paying or receiving cash from a company.

Sales are recorded when a company receives payment for goods, regardless of when the goods are delivered.

In the above-mentioned scenario, If a customer buys items on credit, the company will not book the transaction until the cash for sale is paid.

If a buyer is prepaying for a transaction, the company must report sales revenue immediately rather than when the products are shipped to the consumer.

The expenses are brought into the records of the company when they are registered whenever charged, regardless of when they are incurred.

Accrual accounting allows revenue to be reported when received (usually when goods are shipped or services are provided to a customer), regardless of when cash hands are exchanged.

Given the above-mentioned scenario, expenditure shall be reported in the same period as the revenues to which it relates.

A corporation that chooses to delay payment of those expenditures under cash accounting so that they are not reported in the current period, resulting in an artificially inflated result.

Accrual accounting requires expenses to be matched to revenues

Generally accepted accounting principles mandate the use of accrual-basis accounting.

Accounting process results are summarized and consolidated reports, or financial statements, presenting an entity’s financial position and operating results.

Financial statements are financial data presentations and accompanying notes prepared by either generally accepted accounting principles (GAAP), such as the International Financial Reporting Standards (IFRS) or the specific accounting standards of a country. Examples include a balance sheet, income statements, and statements of cash flows.

Nevertheless, for most businesses, a complete set of financial statements includes a financial statement (“balance sheet”), a profit or loss statement and other detailed profits (“revenue list”), a statement of adjustments in shareholders ‘ equity or a statement of retained earnings, and a statement of cash flows, as well as additional references to the financial statements.

Yes, it necessary to maintain a balance sheet. The balance sheet, or financial position statement, shows a “snapshot” of the financial situation of a company at a particular point in time, usually the last day of the accounting period.

Assets are a company’s capital. In general, in order of liquidity, assets are viewed on the balance sheet, or how quickly they are supposed to be transformed into cash.

Current assets include all the properties that are expected to be cashed, sold or used up in one year. This category typically includes cash, receivable accounts (the amount that customers owe to a credit sales business), inventory, and prepayment products.

Long-term assets that are unlikely to be converted into cash soon, such as fixed assets (for example, land, buildings, equipment) and intangible assets (for example, patents, trademarks, goodwill).

Fixed assets of a corporation are viewed net of accumulated depreciation, which reflects the cumulative wear-and-tear cost on the properties of a company.

Intangible assets are presented net of accumulated amortization, which represents the collective expense incurred for the decline in the value of intangible assets.

Given the above-mentioned scenario, the company would have to reclassify $5,000 of the note balance to the current liabilities section and show the remaining $70,000 as a long-term liability.

Owners’ equity in a company typically comprises sums from two sources—owner contributions (usually referred to as common or capital stock and paid-in capital) and non-distributed earnings (usually referred to as retained earnings).

When a company’s owners invest in it through the purchase of company stock, the balance in the capital stock account rises.

The retained earnings balance increases when a company has earnings and decreases when a company has losses. The retained earnings account is also decreased when earnings are distributed to a company’s owners in the form of dividends.

The income statement, profit or loss statement, and other detailed profits state how much profit (or loss) a corporation received over a while

Two basic types of accounts are reported on the income statement include:
(A) Revenues Account
(B) Expenses Account

Revenues reflect sums earned during the accounting period from the sale of goods or services.

The word net means that the amount shown is the total sales of the product, minus any refunds on purchases, returns, discounts or allowances.

For a company that produces products, the cost of the goods sold means the amount that the company spent on supplies, wages, and overhead expenses to produce the goods sold in the accounting period

The difference between net sales and cost of goods sold is called gross profit or gross margin.

Gross profit or gross margin is used to represents the amount of leftover from sales to pay the company’s operating expenses.

Operating expenses are those costs that an organization incurred in funding and running its operations. Those usually include items like ads, executive compensation, office supplies, repairs and maintenance, rent, insurance, depreciation, interest, and taxes.

Accrual accounting requires that these items be included on the income statement in the period in which they are incurred, regardless of when they are paid.

A company’s net income or net earnings for the period is determined after subtracting operating expenses from gross profit.

If a company’s total expenses were greater than its total revenues and the bottom line is negative, then it had a net loss for the period.

The total amount(net income for the year) is shown on the balance sheet as retained earnings.

The loss will be deducted from the retained earnings balance at the end of the second year.

It is the sum of dividends and net income. Where net income can be further classified into revenue and expenses.

The statement of cash flows reports a company’s sources and uses of cash during the accounting period.

Potential investors and other interested parties commonly use this statement in combination with the income statement to determine the true financial performance of a company over the period stated.

The amount of cash received and paid during the year is far more difficult to falsify, so that the statement of cash flows increases the transparency of the financial statements.

The cash flow statement is divided into three sections: cash flows from operating activities, cash flows from investment activities, and cash flows from financing activities.

There are two types of measuring transactions cash flows, namely direct method, and the indirect method.

The direct method lists the sources of operating cash flows and the uses of operating cash flows, with net cash flow from operating activities being the difference between them.

The indirect method reconciles net income on an income statement with net cash flows from operating activities; i.e., accrual-based net income is adjusted for non-cash revenues and expenses to meet net operating cash flows.

Cash flows from financing activities involve the cash received or paid in connection with issuing debt and equity securities.

Cash inflows from financial activities occur when a corporation is selling its own stock, issuing bonds or taking out a loan.

GAAP are the laws by which financial transactions of a corporation are registered in their respective account classifications and properly reported as part of the financial statements of the entity.

Financial information is relevant if it has predictive value, confirmatory value, or both.

The confirmatory value means that the information offers input on previous evaluations. Predictive value occurs when the information can be used as an input to systems that consumers use to predict future outcomes.

Materiality is an entity-specific aspect of significance based on nature or value, or both, of the items related to in the financial report of an individual entity.

The confirmatory value means the information offers feedback on previous evaluations. Predictive value exists when information can be used as an input to applications that will be used by users to predict future outcomes.

Free from error is used when the financial reporting data contains no material errors or omissions, and the process used to produce the reported information has been selected and applied without error.

An entity’s management is permitted to change an accounting policy only if the change either:
(A) Is required by a standard or interpretation
(B) Financial Statements results which provide more reliable and relevant information on the effects of transactions; other events; or 
    conditions on the financial position, financial performance or cash flow of the entity

Verifiability helps ensure consumers that the information is accurate and the financial position of the company is accurately portrayed.

The company’s management is needed to provide reports when current incidents or circumstances suggest that it is more likely than not that the organization may not be able to fulfill its obligations within a reasonable time following issuance of the financial statements.

Recognition is the method of adding an object in the balance sheet or income statement that meets the definition of an entity and satisfies the recognition requirements.

An item which meets an element description should be recognized when:
(A) Any future economic benefits associated with this item would possibly flow to or from the company.
(B) The item has a cost or value that can be measured with reliability.

In the acceptance criterion, the definition of probability is used to refer to the degree of uncertainty that the future economic benefits associated with the item would flow to or from the organization.

Nonetheless, some degree of non-payment is normally considered probable for a large population of receivables; hence a cost is recognized which reflects the anticipated reduction in economic benefits. This expense is known as bad debt, and the resulting obligation is the provision of doubtful debts.

This expense is known as bad debt, and the resulting obligation is the provision of doubtful debts.

When a reasonable estimate cannot be made, the item is not recognized in the balance sheet or income statement.

The asset is recorded in the balance sheet when the future economic benefits are expected to flow to the company, and the asset has expense or value that can be accurately calculated.

A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

Income is reflected in the income statement when there has been a rise in future economic gain due to an increase in an asset or a reduction in a liability that can be accurately calculated.

Recognition of profits happens at the same time as accepting changes in assets or reductions in commitments.

Revenue is recognized or recorded when it becomes realized or realizable, and earned.

According to accrual accounting, compensation for work to be done in future accounting periods should not be accepted, even though the work may still be under contract.

Expenses are recorded in the income statement when there has been a decrease in future economic gain due to a reduction in an asset or a rise in a liability that can be calculated accurately.

Expenses are recognized in the income statement based on a direct association between the costs incurred and the earning of specific items of income.

The related theory requires the simultaneous or collective identification of revenues and expenses arising directly and collectively from the same or other transactions.

If economic benefits are likely to occur over several accounting periods and the relation with profits can only be calculated narrowly or indirectly, expenditures are recorded based on standardized and reasonable allocation procedures in the income statement.

Recognizing expenses related to the use of land, plant and equipment; goodwill; and patents and labels. In such cases, the expenditure is considered an amortization or depreciation.

It is recognized immediately in the income statement when an expenditure does not yield any future economic benefits or when, and to the degree that future economic benefits do not qualify for recognition as an asset in the balance sheet, or stop qualifying.

Several different calculation bases are used in financial statements to varying degrees and variations. We include the following:
(A) Historical cost
(B) Current cost
(C) Realizable value
(D) Present value

Liabilities are taken out at the undiscounted amount of cash or cash equivalents which would be needed to satisfy the current obligation.

Current costs — Assets are kept at the amount of cash or cash equivalents that would have to be spent if the same or an equal asset were actually purchased.

Liabilities are reported in the amount of money obtained in return for the debt, or in some cases (e.g., income taxes), in the amounts of cash or cash equivalents expected to be paid in the normal course of business to meet the liability.

They are listed at the amount of cash or cash equivalents paid or the fair value of the fee provided to procure them at the time of their purchase.

Present value — Resources are held at the present discounted value of potential net cash inflows which are projected to be produced by the item in the normal course of business.

The most widely accepted calculation criterion for organizations in preparing their financial statements is the historical expense.

Disadvantages of using it include:
(A) The substance of the transaction is better reflected (and, therefore, the financial statements are more fairly presented) by not 
    strictly following GAAP.
(B) If a transaction is considered immaterial (i.e., it would not affect a decision made by a prudent reader of the financial statements), 
    then it need not be reported.
(C) There is concern that assets or income would be overstated.
(D) The results of departure appear reasonable under the circumstances, especially when strict adherence to GAAP would produce unreasonable 
    results and the departure is properly disclosed.

The three major types of occupational fraud are:
(A) Corruption
(B) Asset misappropriation
(C) Financial statement fraud.

Financial statement fraud is the deliberate misrepresentation of an enterprise’s financial condition achieved by intentional error or omission of sums or reports in the financial statements to mislead users of the financial statements.

The distinctive factor between mistake and fraud is whether the underlying conduct resulting in the financial statements being misrepresented is intentional or unintentional.

Financial statement fraud almost always involves overstating assets, revenues, and profits and understating liabilities, expenses, and losses.

Fraud investigations are usually performed or monitored by management, fraud cases on financial statements often occur for a long time before the fraud is detected.

There are several reasons why people commit fraud from financial statements. Most generally, deceit in the financial report is used to make the results of the business look better on paper. There are several reasons why people commit fraud from financial statements. Most generally, deceit in the financial report is used to make the results of the business look better on paper. To encourage investment through the sale of stock. To avoid negative market perceptions.

Fraud in financial statements happens through a variety of methods, such as value decisions and timing manipulation for reporting transactions. Such subtler forms of fraud are often dismissed as either mistakes or errors in judgment and calculation.

Examples of situational pressures include sudden declines in revenue or market share experienced by a company or industry, unrealistic budgetary pressures, especially for short-term outcomes and financial pressures resulting from short-term economic performance bonus plans.

Some of the more obvious opportunities for the existence of fraud are:
(A) Absence of a board of directors or audit committee
(B)Improper oversight or other neglectful behavior by the board of directors or audit committee
(C) Weak or nonexistent internal controls, including an ineffective internal audit staff and a lack of external audits
(D) Unusual or complex transactions (an understanding of the transactions, their parts
(E) Financial estimates that require significant subjective judgment by management

The five classifications of financial statement schemes are:
(A) Fictitious revenues
(B) Timing differences
(C) Improper asset valuations
(D) Concealed liabilities and expenses
(E) Improper disclosures

Fictitious or fabricated revenue includes reporting sales of goods or services that have not occurred in contrast with regular revenue that requires legitimate sales records.

Following are the examples of a red flag that is associated with Fictitious revenues:
(A) A significant volume of sales to entities whose substance and ownership is not known
(B) Significant transactions with related parties
(C) Unusual profitability, especially compared to that of other companies in the same industry
(D) An unusually large amount of long-overdue accounts receivable

In the accounting records, revenue should usually be recorded when a transaction is complete — that is, when the title is transferred from the seller to the buyer. The ownership transfer completes the sale and is typically not final until all responsibilities related to the sale are complete.

To achieve compliance with this revised standard, an entity should apply the following steps:
(A) Identify the contract(s) with a customer.
(B) Identify the performance obligations in the contract.
(C) Determine the transaction price.
(D) Allocate the transaction price to the performance obligations in the contract.
(E) Recognize revenue when (or as) the entity satisfies a performance obligation.

Sales with conditions are those with terms that have not been fulfilled, and those with ownership rights and threats that have not been passed on to the buyer.

Such sales can in most cases not be recorded as income. Such types of sales are similar to schemes involving the recognition of income in inappropriate periods, as the conditions for sale may be met in the future, at which point the recognition of income would become appropriate.

Long term contracts may cause special income recognition problems. For example, in many countries, long-term construction contract revenues and expenditures can be reported using either the completed-contract method or the percentage-of-completion method, depending partly on the circumstances. The completed-contract method does not record revenue until 100 percent of the project is complete.

Financial reporting fraud risks associated with multiple-element revenue arrangements include:
(A) Falsely claiming that the criteria for a multiple-element revenue arrangement have been met.
(B) Manipulating the allocation of revenue among the individual components of the arrangement to accelerate revenue recognition.

For certain goods, there may be a greater risk of returns if they can not be sold until their shelf life expires.

Due to demands to achieve budget forecasts and targets, or due to lack of proper accounting controls, accurate reporting of expenditures is often compromised.

Some examples of Red Flags Are Associated with Timing Differences include:
(A) Unusual increase in gross margin
(B) Recurring negative cash flows from operations
(C) Unusual growth in the days’ sales in receivables ratio
(D) Rapid growth

The net effect is seen in the current ratio, which divides current assets by current liabilities to evaluate a company’s ability to satisfy its short-term obligations.

The net impact of misclassification of long-term assets on the current ratio rises as a short-term effect.