Ch8 Exam Prep + Fraud Detection Red Flags and Targeted Risk

CHAPTER 8

1. _______________ must take the lead in establishing, implementing, and maintaining a formal fraud risk management program.

A. Corporate shareholders

B. Board and management

C. Regulatory agencies such as the PCAOB and SEC

D. Internal auditors

2. “Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, authorize, record, process, and report transactions (as well as events and conditions) consistent with management’s assertions embodied in in the financial statements.” What is the source of this standard?

A. SAS No. 1

B. COSO Internal Control Framework, Section 3

C. SEC Regulation D Rule 502

D. PCAOB Standard No. 1

3. Because prevention through segregation of duties, approvals, and authorizations is not possible in a collusive environment, the principal internal control procedures will be centered on _____________.

A. Authority

B. Mitigation

C. Detection

D. Deterrence

4. Generally, three procedures are effective in identifying breakdowns in internal controls due to override and collusion: journal entries recording in the books and records, as well as other adjustments to financial information should be examined for proper back-up document; significant accounting estimates needs to be reviewed; and ___________________________.

A. Care should be taken by the board to ensure that the external auditor is indeed, independent in fact, and in appearance.

B. A properly functioning board-operated audit committee which has the ability to independently investigate anomalies should be established.

C. A robust whistleblower mechanism should be implemented and its existence widely published throughout the organization.

D. Unusual “one-time” transactions should be scrutinized to ensure they have an appropriate underlying business rationale.

5. The 2016 ACFE Report to the Nations found that ___________ of existing controls is the second most frequently observed internal control weakness that contributed to fraud; the lack of internal controls was the only weakness more frequently cited by the ACFE’s survey respondents.

A. A lack of clarity

B. A lack of awareness

C. Overly complex design

D. Override

6. The perception of the public—particularly with regard to asset misappropriation, corruption, and misstated financial statements—is that independent auditors are:

A. Largely corrupt and untrustworthy themselves

B. Responsible for fraud detection

C. Not generally trained in the specific techniques of fraud examination

D. Antiquated in the age of big data and artificial intelligence (AI)

7. When conducting an audit, the auditor has a responsibility to design audit tests to address the risk of management override of internal controls. _____________ can be discerned by looking for evidence of concealment such as missing documents, altered documents, nonreconcilable items, misinformation obtained during management inquiries, and other indicators of concealment.

A. Errors

B. Scope

C. Intent

D. Red flags

8. _______________ is a relative concept. A misstated amount that would be immaterial to a large company could be large enough to wipe out the net worth of most small companies.

A. Materiality

B. Truth

C. Fraud

D. An external audit

9. The materiality amount—once established—is _______________ for the duration of the audit engagement.

A. Essentially a footnote

B. Not set in stone

C. Fixed and cannot be adjusted

D. Determined by management

10. ____________ involves deliberate actions by management to meet specific earnings objectives, generally for private gain.

A. “Earnings management”

B. “Willful non-transparency”

C. “Vertical and horizontal ratios”

D. “Ego/Entitlement”

11. Management has some latitude to manage earnings as long as the choices are considered ____________, however, any sign of deliberate efforts to do so should be considered a red flag by auditors, because it can be fraud, whether or not material.

A. Reasonable by investors

B. Necessary to achieve performance bonuses

C. GAAP-compliant

D. Board approved

12. The board’s audit committee is __________________ with regard to management override and high-level management collusion.

A. A persistent relic of another era in management

B. An unnecessary layer if an internal auditor (or team) exists

C. An optional approach to board oversight but not recommended for publicly traded companies

D. An integral internal control mechanism

13. The primary deterrent effect of an internal audit group is related to:

A. The skillsets of the individual(s) involved.

B. Its ability to parse large volumes of data.

C. The increased perception that fraud perpetrators will be detected.

D. Assisting senior management in establishing the “tone at the top.”

14. A major difference between auditors and fraud examiners is that most auditors __________________. Fraud examiners and forensic accountants who detect fraud go beyond this. They determine whether __________________, whether expenditures make sense, and whether all aspects of the documentation are in order.

A. Are not trained in detecting fraud; red flags exist

B. Merely match documents to numbers to see whether support exists and is adequate; the documents are real or fraudulent

C. Have at least a 5% threshold for materiality; fraud at any threshold exists

D. Don’t have the interview skills to assess fraud; people make inconsistent statements

15. In most cases, asset misappropriation, corruption, and financial statement fraud last about ____________ from inception to conclusion.

A. 24 months

B. 6 months

C. 2.4 months

D. 16 months

16. __________________ is an attempt to identify the fraud as early as possible, in contrast to the optimal situation in which the fraud is prevented or deterred.

A. Conducting an annual fraud risk assessment

B. Separation of duties

C. Effective fraud detection

D. Implementing internal controls that prevent collusion

17. ____________ are part of the day-to-day operations of most organizations and are often observed by auditors.

A. Earnings management

B. Transaction adjustments

C. Risks

D. Anomalies

18. The starting point for the antifraud professional or forensic accountant is an attitude of ______________________.

A. Professional skepticism

B. Unbiased professionalism

C. Professional pessimism

D. Professional rigor

19. Generally, enhanced skepticism has three defining elements. First it includes the recognition that fraud may be present. Second, professional skepticism is exemplified by a professional’s attitude, an attitude that includes a questioning mind and a critical assessment of evidence. Third, professional skepticism asks professionals to make a commitment to __________________________.

A. Doing whatever it takes to convict the guilty

B. Persuasive evidence to determine whether or not fraud is present

C. Never giving up when it comes to identifying and locating more evidence

D. Extending a presumption of goodwill unless or until evidence suggests otherwise

20. Fraud detection techniques require that fraud and forensic accounting professionals pay particular attention to the possibility of ________________ because it suggests deception.

A. Concealment

B. Collusion

C. Override of internal controls

D. Conversion

21. There are two major approaches to fraud detection:

A. Through tips (allegations) and the preponderance of evidence

B. Through external audits and internal audits

C. Through the identification of red flags and through a targeted risk assessment

D. Through the use of covert and overt surveillance (both physical and digital)

22. The first step to detecting fraud is to build an understanding of the organization and the environment in which it operates. The second step is to ______________________.

A. Develop an understanding of the control environment—the environment as opposed to the controls themselves.

B. Develop an audit plan that includes discussions with senior management about potential fraud risks

C. Develop a network of insiders who may have knowledge of actual fraud

D. Remind your team of the importance of professional skepticism

23. Most red flags are:

A. Indicators of fraud if one knows how and where to look.

B. Typically, indicative of fraud if a targeted risk assessment was not completed.

C. Not indicators of fraud but are a function of the dynamic environment in which organizations operate.

D. Indicators of unskilled fraudsters who don’t have sufficient knowledge to conceal their defalcations.

24. Irregularities such as missing documents, excessive voids or credit memos, excessive write-offs, duplicate payments, second endorsement on checks, and questionable handwriting are all examples of:

A. Accounting anomalies

B. Analytical anomalies

C. Behavioral red flags

D. Internal control irregularities and weaknesses

25. From a fraud perspective, internal controls have at least three different objectives:

A. Increase perception of detection, improve deterrence, and create a reporting mechanism

B. Deterrence, detection, and mitigation

C. Segregation of duties, checks and balances, and detection

D. Prevention, deterrence, and detection

26. Data such as laundromat electricity usage and cycle time, beer purchase quantities, and travel dates are examples of:

A. Accounting anomalies

B. Nonfinancial numerical performance data

C. Red flags that have little to no potential value in verifying or disproving fraud

D. Tend to be “corrupted” sources of data

27. The targeted fraud risk assessment approach assumes that there should be a direct relationship between the ________________ and the _________________________.

A. Specific industry involved; risk levels typically associated with that industry

B. Accounts receivable department; accounts payable department

C. Level of risk associated with a material weakness in the company’s controls; amount of attention devoted to that area during an audit

D. Organization’s tolerance for risk; implementation of appropriate internal controls

28. An overview of the fraud risk assessment process includes the following components:

A. Propose the scope of the audit, execute the scope, report the findings to the board, and reply to management concerns.

B. Money, Ideology, Coercion, and/or Ego/Entitlement (MICE).

C. Act, concealment, and conversion.

D. Evaluate the fraud risk factors, identify possible fraud schemes and scenarios, prioritize individual fraud risks, evaluate mitigating controls.

29. The text outlines a ten-step approach to implementing a targeted fraud risk assessment. Which of the following is NOT one of those steps.

A. Identify the “process owner” for each of the identified significant processes.

B. Identify the parties who have the ability to commit the potential fraud.

C. Identify specific vendors that have a reputation for fraud within the industry.

D. Identify, understand, and evaluate the company’s operating environment and the pressures that exist.

30. When the text refers to a “process owner,” it is referring to an individual who has:

A. Subject matter expertise in the processes that should be used within the industry.

B. Significant influence or sway in the processes used by the organization to accomplish its goals, but little ability to alter those processes despite “owning” them.

C. The responsibility for conducting a particular aspect of a targeted fraud risk assessment.

D. Day-to-day authority and ability to alter standard operating procedures to accomplish the goals and objectives of the organization.

31. Residual fraud risk includes those _______________ that are not adequately mitigated by control activities, and, as such, requires a fraud audit response.

A. Fraud schemes

B. Personnel

C. Industry norms

D. Company specific characteristics

32. The risk of management override and collusion are _________ residual fraud risks and require a specific audit response, if detection activities do not exist.

A. Occasionally

B. Always

C. Rarely

D. Never

33. In an electronic environment that captures a huge amount of transactions annually, many transactions and data relationship anomalies appear to be a potential fraud or error. To utilize the computer environment effectively, _________________ must be completed.

A. The targeted fraud risk assessment process

B. A hypothesis/null hypothesis matrix

C. CAATT training by the auditor or examiner

D. A Benford analysis on all journal entries

34. The most challenging issue regarding fraud detection in a digital environment is the potential for:

A. The inherent susceptibility of digitally stored data to be fraudulently altered without detection.

B. Historical transaction data to be lost over time due to the high costs of digital storage.

C. An over-whelming number of fraud symptoms (i.e., red flags).

D. Hackers and other unauthorized users gaining access to proprietary information.