Certified Fraud Examiner Financial Statement Fraud Questions and Answers — Questions and Answers
Question 1: A company has been consistently reporting significant revenue growth and high net income, yet its operating cash flow is persistently negative. This discrepancy is most likely a red flag for which of the following financial statement fraud schemes?
- Improper asset valuation
- Concealed liabilities and expenses
- Fictitious revenues (Correct answer)
- Improper disclosures
Correct answer: Fictitious revenues
When a company records fictitious sales, it increases its reported revenue and net income, but no cash is actually collected. This leads to a growing gap between net income and operating cash flow, as the cash flow statement will reflect the lack of actual cash receipts.
Question 2: An external auditor is examining a manufacturing company's financial statements. Which of the following findings would be the STRONGEST indicator of improper asset valuation?
- The company changed its inventory valuation method from LIFO to FIFO during the year.
- There has been a significant increase in the allowance for doubtful accounts.
- The company has a large number of complex related-party transactions that are not clearly described in the footnotes.
- Fixed assets are recorded at values significantly higher than their current market appraisal, with minimal accumulated depreciation. (Correct answer)
Correct answer: Fixed assets are recorded at values significantly higher than their current market appraisal, with minimal accumulated depreciation.
Recording fixed assets at values well above their market appraisal and applying minimal depreciation is a direct method of inflating asset values on the balance sheet. This overstates the company's net worth and can mislead investors and creditors about its true financial health.
Question 3: A retail company is suspected of concealing liabilities to improve its debt-to-equity ratio. Which of the following actions would be a common way to perpetrate this type of fraud?
- Capitalizing operating expenses
- Failing to record warranty obligations for products sold (Correct answer)
- Creating fictitious sales invoices to non-existent customers
- Stuffing distribution channels with more product than can be sold
Correct answer: Failing to record warranty obligations for products sold
Failing to record warranty obligations is a form of concealing liabilities. By not recognizing this future obligation as a liability, the company understates its total liabilities, thereby artificially improving its debt-to-equity ratio and overall financial appearance.
Question 4: During a fraud examination of a construction company that uses the percentage-of-completion method for revenue recognition, a fraud examiner discovers that management has been manipulating the estimated costs to complete long-term projects. What is the most likely fraudulent outcome of this manipulation?
- Understatement of liabilities
- Premature revenue recognition (Correct answer)
- Overstatement of inventory
- Concealment of expenses
Correct answer: Premature revenue recognition
By artificially lowering the estimated costs to complete a project, management can inflate the calculated percentage of completion. This leads to recognizing a larger portion of the total contract revenue in the current period than is actually warranted, which is a form of premature revenue recognition.
Question 5: Which of the following is a common technique used to perpetrate a timing difference fraud scheme?
- Recording fictitious assets to offset fake sales
- Omitting significant contingent liabilities from the financial statement disclosures
- Keeping the sales journal open past the period's cutoff date (Correct answer)
- Improperly capitalizing research and development costs
Correct answer: Keeping the sales journal open past the period's cutoff date
Keeping the sales journal open after the end of the accounting period allows a company to include sales from the next period in the current period's results. This is a classic timing difference scheme designed to improperly accelerate revenue recognition and inflate current period earnings.
Question 6: A fraud examiner is reviewing a company's financial statements and notices a significant increase in gross margin, which is inconsistent with industry trends. Additionally, the days' sales in receivables ratio has increased dramatically. This combination of red flags is most indicative of which financial statement fraud scheme?
- Improper asset valuation
- Concealed liabilities and expenses
- Improper disclosures
- Fictitious revenues (Correct answer)
Correct answer: Fictitious revenues
Recording fictitious revenues increases the gross margin because there are no associated costs of goods sold. It also increases the days' sales in receivables ratio because the fake sales result in accounts receivable that are never collected, causing the receivables balance to grow disproportionately to actual sales.
Certified Fraud Examiner Financial Statement Fraud Questions and Answers
A company has been consistently reporting significant revenue growth and high net income, yet its operating cash flow is persistently negative.
This discrepancy is most likely a red flag for which of the following financial statement fraud schemes?