Question

Question 1  

• Which of the following would be a “red flag” of potential financial statement fraud for a nonpublic company that would need further investigation?

a	The Company issued annual GAAP financial statements on February 28th, even though its books were closed on January 15th.
b	The GAAP financial statements were “reviewed” by a CPA in accordance with AICPA standards, but the Company has never undergone a financial statement audit in accordance with GAAS.
c	The Company has changed auditors annually for the last 4 years because of disagreements regarding the application of accounting principles.
d	The financial statements present only the current year’s financial statements instead of comparative financial statements for at least two years.

Question 2  

• You have been engaged to audit the Financial Statements of Falcon Industries, Inc., a large multi-industry Company that is planning to go public in the near term. You have made several observations about the Company’s financial statement disclosures that might be a “red flag” of inappropriate financial reporting. Which of these is the most suspect?

a	The financial statements do not include a disclosure about a well-publicized high dollar employee sexual harassment lawsuit that is currently under settlement negotiations.
b	The financial statements include a disclosure about a material transaction with a related party.
c	The financial statements include a disclosure regarding changes in the estimated depreciable life of a material fixed asset.
d	The financial statements include a transaction with a foreign government that represents 4% of total revenues for which there is no disclosure in the financials.

Question 3  

• While auditing the GAAP financial statements of your client Mequon Iron & Steel Ltd., you notice a few items that you believe might be “red flags” of improper revenue recognition. Which audit procedure would be most helpful in determining whether the Company has included any fictitious sales in its reported revenues?

a	Analyzing the changes in the quick and current ratios year over year.
b	Analyzing credits to AR and offsetting debits to revenue in the month following year-end.
c	Examining whether the sales journal was closed out prior to the end of the fiscal year.
d	Performing a search for unrecorded sales a few days before fiscal year-end.

Question 4  

• Financial statement ratio analysis can be helpful in identifying the warning signs of financial statement fraud. Which of the following results of a ratio analysis of your client’s income statement would most likely raise a “red flag” and warrant further investigation?

a	Industry average gross margin is 55%, and the client’s gross margin is 57%.
b	Lease expense accounted for 10% of total general and administrative expenses in previous years, but this year it is 12%.
c	In the current year revenues increased 25% over the previous year’s revenues. COGS increased 6% over the previous year.
d	Payroll expense increase 5% this year, while previous years’ increases averaged 9%.

Question 5  

• During your audit of Wisconsin Freight Rail, Inc., a public company, you uncover evidence that indicates several mid-level managers are colluding in a nonmaterial asset misappropriation scheme. Which of the following best describes the auditors’ reporting responsibility of this evidence under Auditing Standard (AS) No. 2401, Consideration of Fraud in a Financial Statement Audit?

a	Because the scheme is not material to the financial statements, the audit team has no obligation to report the evidence of fraud to the Board of Directors Audit Committee.
b	The audit team should report the evidence directly to the Securities and Exchange Commission
c	The audit team should report the evidence to the appropriate level of executive management.
d	Because the fraud is an asset misappropriation scheme and does not involve senior or executive management, the audit team dos not have any obligation to report the evidence to any party

Answer 1

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Answer 1

Which of the following would be a “red flag” of potential financial statement fraud for a nonpublic company that would need further investigation?

Option C

The Company has changed auditors annually for the last 4 years because of disagreements regarding the application of accounting principles.

Answer 2

You have been engaged to audit the Financial Statements of Falcon Industries, Inc., a large multi-industry Company that is planning to go public in the near term. You have made several observations about the Company’s financial statement disclosures that might be a “red flag” of inappropriate financial reporting. Which of these is the most suspect?

Option D

The financial statements include a transaction with a foreign government that represents 4% of total revenues for which there is no disclosure in the financials.

Answer 3

While auditing the GAAP financial statements of your client Mequon Iron & Steel Ltd., you notice a few items that you believe might be “red flags” of improper revenue recognition. Which audit procedure would be most helpful in determining whether the Company has included any fictitious sales in its reported revenues?

Option B

Analyzing credits to AR and offsetting debits to revenue in the month following year-end.

Answer 4

Financial statement ratio analysis can be helpful in identifying the warning signs of financial statement fraud. Which of the following results of a ratio analysis of your client’s income statement would most likely raise a “red flag” and warrant further investigation?

Option C

In the current year revenues increased 25% over the previous year’s revenues. COGS increased 6% over the previous year.

Answer 5

During your audit of Wisconsin Freight Rail, Inc., a public company, you uncover evidence that indicates several mid-level managers are colluding in a nonmaterial asset misappropriation scheme. Which of the following best describes the auditors’ reporting responsibility of this evidence under Auditing Standard (AS) No. 2401, Consideration of Fraud in a Financial Statement Audit?

Option C

The audit team should report the evidence to the appropriate level of executive management.