Occupational Fraud Schemes

Question 1

Which of the following is a typical method used to make corrupt payments in corruption schemes?

A. Gifts, travel, and entertainment
B. Payment toward credit card debt
C. Checks and other financial instruments
D. All of the above

Answer 1

D. All of the above

See pages 1.609-1.610 in the Fraud Examiner’s Manual

Often, corruption schemes involve corrupt payments—items of value paid to procure a benefit contrary to the rights of others. There are various ways to make corrupt payments, and many do not involve money. Any tangible benefit given or received with the intent to corruptly influence the recipient can be an illegal payment, and traditional methods of making corrupt payments include:

• Gifts, travel, and entertainment
• Cash payments
• Checks and other financial instruments
• Hidden interests
• Loans
• Credit cards
• Transfers not at fair market value
• Promises of favorable treatment

Question 2

The accounts receivable clerk should be responsible for preparing the bank deposit.

A. True
B. False

Answer 2

B. False

See pages 1.330 in the Fraud Examiner’s Manual

The bank deposit should be made by someone other than the cashier or the accounts receivable clerk. A person independent of the cash receipts and accounts receivable functions should compare entries to the cash receipts journal with:

• Authenticated bank deposit slips
• The deposit per the bank statements

Question 3

There is nothing inherently wrong with a company engaging in related-party transactions if the transactions are fully disclosed.

A. True
B. False

Answer 3

A. True

See pages 1.233-1.234 in the Fraud Examiner’s Manual

There is nothing inherently wrong with related-party transactions if they are fully disclosed. If the transactions are not fully disclosed, the company might injure its shareholders by engaging in economically harmful dealings without their knowledge.

Question 4

What financial statement fraud scheme involves recording revenues and expenses in improper periods?

A. Concealed expenses
B. Improper disclosures
C. Timing differences
D. Improper asset valuations

Answer 4

C. Timing differences

See pages 1.215 in the Fraud Examiner’s Manual

Financial statement fraud often involves timing differences—that is, the recording of revenues or expenses in improper periods. This can be done to move revenues or expenses between one period and the next, increasing or decreasing earnings as desired. This practice is also referred to as income smoothing.

Question 5

Off-book sales of goods ALWAYS cause shrinkage.

A. True
B. False

Answer 5

A. True

See pages 1.316 in the Fraud Examiner’s Manual

Off-book sales of goods, otherwise known as skimming, will always leave an inventory shortage and a corresponding rise in the cost of goods sold. When a sale of goods is made, the physical inventory is reduced by the amount of merchandise sold. For instance, when a retailer sells a pair of shoes, there is one less pair of shoes in the stockroom. However, if a fraudster hands over the pair of shoes to a paying customer and keeps their cash without recording the sale, then the inventory balance on the company’s books will be higher than the physical inventory on hand. Thus, there is one less pair of shoes available than the records indicate. Such a reduction in the physical inventory without a corresponding reduction in the perpetual inventory is known as shrinkage.

Question 6

Which of the following is NOT one of the three common methods for concealing liabilities and expenses on a company’s financial statements?

A. Failing to disclose warranty costs and product-return liabilities
B. Channel stuffing
C. Capitalizing expenses
D. Omitting liabilities/expenses

Answer 6

B. Channel stuffing

See pages 1.227 in the Fraud Examiner’s Manual

There are three common methods for concealing liabilities and expenses:

• Omitting liabilities and/or expenses
• Improperly capitalizing costs rather than expensing them
• Failing to disclose warranty costs and product-return liabilities

Question 7

Which of the following scenarios BEST describes a mischaracterized reimbursement expense scheme?

A. An employee alters a receipt to show a higher cost than what the employee paid and submits it for reimbursement.
B. An employee produces a fictitious receipt and includes it with an expense report.
C. An employee submits a receipt for an item in one expense report and an email confirmation for the same item in the next period’s expense report.
D. An employee who travels frequently for business submits receipts from a hotel stay during a family vacation as a business expense.

Answer 7

D. An employee who travels frequently for business submits receipts from a hotel stay during a family vacation as a business expense.

See pages 1.473, 1.475, 1.478, 1.481 in the Fraud Examiner’s Manual

One of the most basic expense reimbursement schemes is perpetrated by requesting reimbursement for a personal expense, claiming that it is business related. Examples of mischaracterized expenses include claiming personal travel as a business trip or listing dinner with a friend as “business development” or “client entertainment.” Employees might submit the receipts from their personal expenses along with their expense reports and invent business reasons for the incurred costs.

Instead of seeking reimbursement for personal expenses, some employees overstate the cost of actual business expenses. This is considered an overstated expense reimbursement scheme.

In a fictitious expense reimbursement scheme, an employee seeks reimbursement for fictitious expenses. Instead of overstating a real business expense or seeking reimbursement for a personal expense, an employee invents an expense by producing a fictitious receipt to request reimbursement.

In a multiple reimbursement scheme, an employee submits several types of support for the same expense to get reimbursed multiple times.

Question 8

The motivation for financial statement fraud almost always involves personal gain.

A. True
B. False

Answer 8

B. False

See pages 1.204-1.205 in the Fraud Examiner’s Manual

Unlike some other types of fraud (such as embezzlement), the motivation for financial statement fraud does not always involve personal gain. Most commonly, financial statement fraud is used to make a company’s earnings appear better than they are. Financial statement fraud occurs through a variety of methods, such as valuation judgments and manipulating the timing of transaction recording. These more subtle types of fraud are often dismissed as either mistakes or errors in judgment and estimation. Some of the more common reasons why people commit financial statement fraud include:

• To encourage investment through the sale of stock
• To demonstrate increased earnings per share or partnership profits interest, thus allowing increased dividend/distribution payouts
• To cover inability to generate cash flow
• To avoid negative market perceptions
• To obtain financing or to obtain more favorable terms on existing financing
• To receive higher purchase prices for acquisitions
• To demonstrate compliance with financing covenants
• To meet company goals and objectives
• To receive performance-related bonuses

Question 9

Which of the following statements is TRUE regarding a fictitious revenue scheme?

A. The debit side of a fictitious sales entry usually goes to accounts payable.
B. Uncollected accounts receivable are a red flag of fictitious revenue schemes.
C. Fictitious revenues must involve sales to a fake customer.
D. If a fictitious revenue scheme has taken place, there will typically be no accounts receivable on the books.

Answer 9

B. Uncollected accounts receivable are a red flag of fictitious revenue schemes.

See pages 1.212 in the Fraud Examiner’s Manual

Fictitious or fabricated revenues involve the recording of sales of goods or services that did not occur. Fictitious sales most often involve fake customers but can also involve legitimate customers. At the end of the accounting period, the sale will be reversed (as will all revenue accounts), which will help to conceal the fraud.

Recording the sales revenue is easy, but the challenge for the fraudster is how to balance the other side of the entry. A credit to revenue increases the revenue account, but the corresponding debit in a legitimate sales transaction typically either goes to cash or accounts receivable. Because no cash is received in a fictitious revenue scheme, increasing accounts receivable is the easiest way to get away with completing the entry. Unlike revenue accounts, however, accounts receivable are not reversed at the end of the accounting period. They stay on the books as an asset until collected. If the outstanding accounts are never collected, they will eventually need to be written off as bad debt expense. Mysterious accounts receivable on the books that are long overdue are a common sign of a fictitious revenue scheme.

Question 10

Which of the following is an example of a fictitious expense reimbursement scheme?

A. An employee alters an electronic receipt using photo-editing software to show a higher cost than what the employee paid.
B. An employee who travels frequently for business submits receipts from a hotel stay during a family vacation as a business expense.
C. An employee submits a receipt for a hotel reservation in one expense report and a copy of the credit card statement showing the same reservation in the next period’s expense report.
D. An employee generates a fake receipt using basic computer software and includes it with an expense report.

Answer 10

D. An employee generates a fake receipt using basic computer software and includes it with an expense report.

See pages 1.473, 1.475, 1.478, 1.481 in the Fraud Examiner’s Manual

Expense reimbursements are sometimes sought by employees for fictitious items. Instead of overstating a real business expense or seeking reimbursement for a personal expense, an employee invents a purchase to request reimbursement. One way to generate a reimbursement for a fictitious expense is to create fraudulent support documents, such as false receipts. Using basic computer software, it is easy for employees to create realistic-looking counterfeit receipts. These counterfeits are often very sophisticated, even including logos of the stores in which the goods or services were allegedly purchased.

Instead of seeking reimbursement for personal expenses, some employees overstate the cost of actual business expenses. This is considered an overstated expense reimbursement scheme.

In a multiple reimbursement scheme, an employee submits several types of support for the same expense to get reimbursed multiple times.

In a mischaracterized expense scheme, an employee requests reimbursement for a personal expense, claiming that it is business related.

Question 11

Which of the following statements is TRUE?

A. Cash larceny schemes are generally more difficult to detect than skimming schemes.
B. Skimming schemes are generally more difficult to detect than cash larceny schemes.
C. Both cash larceny and skimming are equally difficult to detect.
D. Cash distraction is the most difficult type of cash receipts scheme to detect.

Answer 11

B. Skimming schemes are generally more difficult to detect than cash larceny schemes.

See pages 1.301, 1.320 in the Fraud Examiner’s Manual

Skimming is the removal of cash from a victim entity prior to its entry in an accounting system, meaning cash is stolen before it is recorded in the victim organization’s accounts. This aspect of skimming schemes means that there is no direct audit trail. Because the stolen funds are never recorded, the victim organization might not be aware that the cash was ever received. Consequently, it can be difficult to detect that the cash has been stolen. Cash larceny schemes involve the theft of money that has already appeared on a victim company’s books. Accordingly, cash larceny schemes are easier to detect than skimming schemes because they leave an audit trail.

Cash distraction is not a recognized type of cash receipts scheme.

Question 12

A recommended practice to detect expense reimbursement schemes is to compare current period expenses to both historical expenditure amounts and budgeted expense amounts.

A. True
B. False

Answer 12

A. True

See pages 1.481 in the Fraud Examiner’s Manual

Generally, expense account review uses one of two methods: historical comparisons or comparisons with budgeted amounts. A historical comparison compares the balance expended this period in relation to the balance spent in prior, similar periods.

Budgets are estimates of the money or time necessary to complete a task. They are based on experience with consideration for current and future business conditions. Therefore, when comparing actual and budgeted expenses, determining excessive expenses or inaccurate budget estimates is important.

Question 13

Which of the following is TRUE regarding an overstated refund scheme?

A. It is based on an entirely fictitious refund transaction.
B. It requires collusion between the customer and the employee.
C. The company’s inventory balance on the books will be understated.
D. An employee overstates the amount of a legitimate refund and keeps the excess cash.

Answer 13

D. An employee overstates the amount of a legitimate refund and keeps the excess cash.

See pages 1.403 in the Fraud Examiner’s Manual

Rather than create an entirely fictitious refund, some employees merely overstate the amount of a legitimate refund and steal the excess money. For example, if a customer returns $100 worth of merchandise, the employee might record a $200 return. The employee gives the customer $100 in return for the merchandise and then keeps the remaining $100. The customer might or might not be aware of the scheme taking place. This will result in shrinkage of $100 worth of inventory. In other words, the inventory balance on the books will be overstated by the amount of the excess refund.

Question 14

To understate net income and lower income tax liability, an accountant could fraudulently expense costs rather than properly capitalizing them to an asset account.

A. True
B. False

Answer 14

A. True

See pages 1.227, 1.231 in the Fraud Examiner’s Manual

Typically, a fraudster’s goal when committing a financial statement fraud scheme is to make the entity look stronger and more profitable. This goal is often achieved by concealing liabilities and/or expenses. To do this, the fraudster might fraudulently understate liabilities or improperly capitalize a cost that should be expensed.

Just as capitalizing expenditures that should be expensed is improper, so is expensing costs that should be capitalized. The organization might do this to minimize its net income due to tax considerations. Expensing an item that should be depreciated over a period of time would help accomplish that—net income is lower and so are taxes.

Question 15

Belinda used her company credit card to pay for a business dinner at which she was entertaining a client, knowing Belinda’s employer would pay the credit card bill. Belinda saved the receipt and later filed an expense report seeking reimbursement for the cost of the meal, attaching the receipt as support. This is an example of what kind of fraud?

A. Personal purchases with company funds
B. Mischaracterized expense scheme
C. Multiple reimbursement scheme
D. False billing scheme

Answer 15

C. Multiple reimbursement scheme

See pages 1.481 in the Fraud Examiner’s Manual

A multiple expense reimbursement scheme involves the submission of a single expense several times to receive multiple reimbursements. The most frequent example of such a scheme is the submission of several types of support for the same expense. However, rather than file two expense reports, employees might also charge an item to the company credit card, save the receipt, and attach it to an expense report as if they paid for the item themselves. The victim company therefore ends up paying twice for the same expense.

Question 16

Zach was booking travel arrangements for a business trip. He purchased an airline ticket online using his own funds and obtained a receipt for the ticket via email. Using photo-editing software, Zach increased the ticket price on the electronic receipt and submitted the altered receipt to his employer for reimbursement. This is an example of what type of fraud scheme?

A. Mischaracterized expense scheme
B. Multiple reimbursement scheme
C. Overstated expense scheme
D. Personal purchases with company funds

Answer 16

C. Overstated expense scheme

See pages 1.475-1.477 in the Fraud Examiner’s Manual

Instead of seeking reimbursement for personal expenses, some employees overstate the cost of actual business expenses. The most fundamental example of an overstated expense reimbursement scheme occurs when an employee alters a receipt or other supporting documentation to show a higher cost than what the employee paid.

Question 17

A skimming scheme is easier to detect than a cash larceny scheme because it leaves an audit trail.

A. True
B. False

Answer 17

B. False

See pages 1.301, 1.320 in the Fraud Examiner’s Manual

Cash receipts schemes fall into two categories: skimming and larceny. Skimming is defined as the theft of off-book funds, meaning cash is stolen before it is recorded in the victim organization’s accounts. This aspect of skimming schemes means that there is no direct audit trail. Cash larceny schemes, however, involve the theft of money that has already appeared on a victim company’s books. Cash larceny schemes are easier to detect than skimming schemes because they leave an audit trail.

Question 18

Jacob was on a business trip in another city. One night, he met some friends (unrelated to his work) at an expensive restaurant, paid for the group’s meal using his credit card, and said that “the company would pay for it.” He submitted the receipt for the dinner with the legitimate business receipts from the trip and described the dinner as “client entertainment.” What type of scheme did Jacob commit?

A. A mischaracterized expense scheme
B. An overstated expense scheme
C. A fictitious expense scheme
D. A multiple reimbursement scheme

Answer 18

A. A mischaracterized expense scheme

See pages 1.473 in the Fraud Examiner’s Manual

One of the most basic expense reimbursement schemes is perpetrated by requesting reimbursement for a personal expense, claiming that it is business related. Examples of mischaracterized expenses include claiming personal travel as a business trip or listing dinner with a friend as “business development” or “client entertainment.” Employees might submit the receipts from their personal expenses along with their expense reports and invent business reasons for the incurred costs.

Question 19

Which of the following is an example of an off-book fraud?

A. Cash larceny
B. Ghost employee schemes
C. Skimming
D. Billing schemes

Answer 19

C. Skimming

See pages 1.301 in the Fraud Examiner’s Manual

Skimming is the removal of cash from a victim entity prior to its entry in an accounting system. Employees who skim from their companies steal sales or receivables before they are recorded in the company books. Because of this aspect of their nature, skimming schemes are known as off-book frauds; they leave no direct audit trail. Cash larceny, billing schemes, and ghost employee schemes all involve the misappropriation of cash that has already been recorded on the victim’s books.

Question 20

Which of the following statements about detecting a cash larceny scheme is TRUE?

A. Someone other than the accounts receivable clerk should prepare the bank deposit
B. If employees who handle cash go on vacation, other employees should take over their duties
C. Reconciling the cash register total to the amount of cash in the drawer is helpful in detecting a cash larceny scheme
D. All of the above

Answer 20

D. All of the above

See pages 1.329-1.330, 1.332 in the Fraud Examiner’s Manual

Mandatory vacations are an excellent method of detecting cash fraud. If mandatory vacations are within the company’s policies, then it is important that another individual continues to perform the normal workload of an absent employee. The purpose of mandatory vacations is lost if the work is allowed to remain undone during the employee’s time off.

In contrast to skimming schemes, the register records should not match up with the cash in the drawer when a cash larceny scheme has occurred. For this reason, cash larceny schemes are much easier to detect than skimming schemes because they leave an audit trail. To detect a cash larceny scheme, one recommended practice is to perform independent reconciliations of the register totals to the amount of cash in the drawer.

The bank deposit should be made by someone other than the cashier or the accounts receivable clerk. A person independent of the cash receipts and accounts receivable functions should compare entries to the cash receipts journal with:

• Authenticated bank deposit slips
• The deposit per the bank statements

Question 21

Improperly recording an expenditure as a capitalized asset rather than recording it as an expense would have what effect on the financial statements?

A. Assets would be falsely overstated, giving the appearance of a stronger company
B. Expenses would be overstated, giving the appearance of poor financial performance
C. Net income would be falsely understated, lowering the company’s tax liability
D. None of the above

Answer 21

A. Assets would be falsely overstated, giving the appearance of a stronger company

See pages 1.230 in the Fraud Examiner’s Manual

Improperly capitalizing expenses is one way to increase income and assets and make the entity’s financial position appear stronger. If ineligible expenditures are capitalized as assets and not expensed during the current period, income will be overstated. As the assets are depreciated, income in following periods will be understated.

Question 22

Payers can make corrupt payments by giving recipients hidden interests in profit-making enterprises.

A. True
B. False

Answer 22

A. True

See pages 1.609 in the Fraud Examiner’s Manual

A payer might make a corrupt payment by giving the recipient a hidden interest in a joint venture or other profit-making enterprise.

Question 23

Which of the following is a basic method used to prove corrupt payments in corruption schemes?

A. Using an inside witness
B. Identifying and tracing payments through audit steps
C. Secretly infiltrating ongoing transactions
D. All of the above

Answer 23

D. All of the above

See pages 1.613 in the Fraud Examiner’s Manual

There are three basic ways to prove corrupt payments:

• Use an inside witness.
• Secretly infiltrate or record ongoing transactions.
• Identify and trace the corrupt payments through audit steps.

Question 24

A large amount of overdue accounts receivable on the books is a red flag of a fictitious revenue scheme.

A. True
B. False

Answer 24

A. True

See pages 1.212 in the Fraud Examiner’s Manual

Fictitious or fabricated revenues involve the recording of sales of goods or services that did not occur. Fictitious sales most often involve fake customers but can also involve legitimate customers. Recording the sales revenue is easy, but the challenge for the fraudster is how to balance the other side of the entry. A credit to revenue increases the revenue account, but the corresponding debit in a legitimate sales transaction typically either goes to cash or accounts receivable. Because no cash is received in a fictitious revenue scheme, increasing accounts receivable is the easiest way to get away with completing the entry. However, accounts receivable stay on the books as an asset until they are collected. If the outstanding accounts are never collected, they will eventually need to be written off as bad debt expense. Mysterious accounts receivable on the books that are long overdue are a common sign of a fictitious revenue scheme.

Question 25

To help detect cash larceny, the person responsible for collecting incoming cash should also prepare the bank deposits.

A. True
B. False

Answer 25

B. False

See pages 1.332 in the Fraud Examiner’s Manual

The primary means of preventing cash fraud is separation of duties. Whenever one individual has control over the entire accounting transaction (e.g., authorization, recording, and custody), the opportunity is present for cash fraud. Each of the following duties/responsibilities should be separated:

• Cash receipts
• Bank deposits
• Bank reconciliations
• Cash disbursements

If one person has the authority to collect the cash, deposit the receipts, record that collection, and disburse company funds, the risk of fraud is high.

Question 26

All the following are types of payroll schemes EXCEPT:

A. Stolen paychecks
B. Falsified hours and salary
C. Ghost employees
D. Commission schemes

Answer 26

A. Stolen paychecks

See pages 1.455 in the Fraud Examiner’s Manual

In general, payroll schemes fall into one of the following categories:

• Ghost employees
• Falsified hours and salary
• Commission schemes

When an employee steals paychecks, the scheme is categorized as check tampering, not payroll fraud. The reason is that the basis of the scheme is stealing the check, not generating false payroll disbursements.

Question 27

Early revenue recognition is classified as what type of financial fraud scheme?

A. Fictitious revenues
B. Timing differences
C. Improper asset valuations
D. Improper disclosures

Answer 27

B. Timing differences

See pages 1.215 in the Fraud Examiner’s Manual

Financial statement fraud might involve timing differences—that is, the recording of revenues or expenses in improper periods. This can be done to move revenues or expenses between one period and the next, increasing or decreasing earnings as desired. Early revenue recognition is a common type of timing difference scheme because companies often try to make themselves look as profitable as possible. This practice is also referred to as income smoothing.

Question 28

Jackson is a receiving clerk at a warehouse. His job is to count the number of units in incoming shipments, record the amounts in receiving reports, and forward copies of the reports to the accounts payable department. One day, Jackson received a box of twenty laptop computers at the warehouse. His wife’s computer recently broke, so he stole one of the computers from the box. To conceal his scheme, Jackson sent a receiving report to accounts payable that twenty computers arrived, but he only recorded 19 on the copy of the receiving report used for the inventory records. What type of scheme did Jackson commit?

A. A noncash larceny scheme
B. A purchasing and receiving scheme
C. An asset transfer scheme
D. None of the above

Answer 28

B. A purchasing and receiving scheme

See pages 1.507 in the Fraud Examiner’s Manual

One of the most common examples of an employee abusing the purchasing and receiving functions occurs when a person charged with receiving goods on the victim company’s behalf—such as a warehouse supervisor or receiving clerk—falsifies the records of incoming shipments. If, for example, 1,000 units of a particular item are received, the perpetrator indicates that only 900 were received. By marking the shipment short, the perpetrator can steal the 100 unaccounted-for units.

The obvious problem with this kind of scheme is the fact that the receiving report does not match the vendor’s invoice, which will likely cause a problem with payment. Some employees avoid this problem by altering only one copy of the receiving report. The copy that is sent to accounts payable indicates receipt of a full shipment, so the vendor will be paid without any dispute. The copy used for inventory records indicates a short shipment so that the assets that are readily available will equal the assets in the perpetual inventory.

Question 29

Which of the following is a method that would help prevent the theft of company inventory?

A. Using prenumbered shipping documents, perpetual inventory records, and inventory receiving reports
B. Restricting inventory access to authorized personnel
C. Separating responsibility for incoming shipments and completing the inventory requisition form
D. All of the above

Answer 29

D. All of the above

See pages 1.516-1.517 in the Fraud Examiner’s Manual

There are four basic measures that might help prevent inventory fraud, if properly installed and implemented. They are proper documentation, separation of duties (including approvals), independent checks, and physical safeguards.

Different personnel should be responsible for the following duties:

• Requisition of inventory
• Receipt of inventory
• Disbursement of inventory
• Conversion of inventory to scrap
• Receipt of proceeds from disposal of scrap

In addition, all merchandise should be physically guarded and locked; access should be limited to authorized personnel only.

Finally, the following documents should be prenumbered and controlled:

• Purchase orders
• Receiving reports
• Perpetual records
• Raw materials requisitions
• Shipping documents
• Job cost sheets

Question 30

Performing a physical inventory count is an effective way to detect a skimming scheme.

A. True
B. False

Answer 30

A. True

See pages 1.316-1.317 in the Fraud Examiner’s Manual

In a skimming scheme, the fraudster either fails to report sales or understates them. As a result, the inventory balance on the books will be higher than the physical inventory on hand, since the fraudster is handing over inventory to paying customers and keeping their cash without recording the sales. In other words, inventory leaves the company’s possession, but the inventory balance on the books does not reflect this. This is referred to as shrinkage.

Detailed inventory control procedures can be used to detect inventory shrinkage due to unrecorded sales. In addition to physical inventory counts, inventory detection methods include statistical sampling, trend analysis, reviews of receiving reports and inventory records, and verification of material requisition and shipping documentation.

Question 31

All of the following are measures that would be helpful in preventing cash larceny schemes EXCEPT:

A. Having all employees use the same cash register for their transactions
B. Ensuring that the duties of making bank deposits and performing bank reconciliations are assigned to different individuals
C. Assigning an employee’s duties to another individual when that employee goes on vacation
D. Sending out a company-wide communication informing employees of the company’s surprise cash-count policy

Answer 31

A. Having all employees use the same cash register for their transactions

See pages 1.331-1.333 in the Fraud Examiner’s Manual

Surprise cash counts and supervisory observations can be useful fraud prevention methods. It is important that employees know that cash will be counted on a periodic and unscheduled basis.

Having all employees use the same cash register will not deter cash larceny. However, each employee should have a unique code to the cash registers to facilitate detection of such schemes.

Mandatory vacations are an excellent method of detecting cash fraud. If mandatory vacations are within the company’s policies, then it is important that another individual continues to perform the normal workload of an absent employee. The purpose of mandatory vacations is lost if the work is allowed to remain undone during the employee’s time off.

The primary means of preventing cash fraud is separation of duties. Whenever one individual has control over the entire accounting transaction (e.g., authorization, recording, and custody), the opportunity is present for cash fraud. Each of the following duties/responsibilities should be separated:

• Cash receipts
• Bank deposits
• Bank reconciliations
• Cash disbursements

Therefore, no one person, including the accounts receivable clerk, should be responsible for both depositing cash at the bank and performing bank reconciliations.

Question 32

Which of the following is NOT a method that a fraudster might use to conceal inventory shrinkage?

A. Altering the perpetual inventory records to decrease the balance
B. Falsely increasing the perpetual inventory figure
C. Writing off stolen inventory as scrap
D. Physical padding of inventory

Answer 32

B. Falsely increasing the perpetual inventory figure

See pages 1.510-1.512 in the Fraud Examiner’s Manual

Altering the perpetual inventory figure is one method that can be used to conceal inventory shrinkage. However, increasing the perpetual inventory record would only worsen the shrinkage problem. Instead, a fraudster should falsely decrease the perpetual inventory record to match the lower physical inventory count.

Alternatively, some employees try to make it appear as though there are more assets present in the warehouse or stockroom than there actually are by physically padding the inventory. Empty boxes or boxes filled with bricks or other inexpensive materials, for example, might be stacked on shelves to create the illusion of extra inventory.

Fraudulently writing off stolen inventory as scrap is also a relatively common way to remove assets from the books before or after they are stolen. This eliminates the problem of shrinkage that inherently exists in every case of noncash asset misappropriation.

One of the simplest methods for concealing shrinkage is to alter the perpetual inventory record so that it matches the physical inventory count. This is also known as a forced reconciliation of the account. In the case of misappropriated inventory, the physical count would be lower than the perpetual records, so the perpetual inventory figure would have to be decreased.

Question 33

Which of the following types of accounting changes must be disclosed in an organization’s financial statements?

A. Changes in accounting principles
B. Changes in estimates
C. Changes in reporting entities
D. All of the above

Answer 33

D. All of the above

See pages 1.234-1.235 in the Fraud Examiner’s Manual

In general, three types of accounting changes must be disclosed to avoid misleading the user of financial statements: changes in accounting principles, estimates, and reporting entities. Although the required treatment for these accounting changes varies for each type and across jurisdictions, they are all susceptible to manipulation. For example, fraudsters might fail to properly restate financial statements retroactively for a change in accounting principle if the change causes the company’s financial statements to appear weaker. Likewise, they might fail to disclose significant changes in estimates such as the useful life and estimated salvage values of depreciable assets or the estimates underlying the determination of warranty or other liabilities. They might even secretly change the reporting entity by adding entities owned privately by management or by excluding certain company-owned units to improve reported results.

Question 34

A register disbursement scheme is easier to conceal when cashiers are authorized to void their own transactions.

A. True
B. False

Answer 34

A. True

See pages 1.409 in the Fraud Examiner’s Manual

Red flags of register disbursement schemes include the following:

• There is inappropriate separation of duties for employees.
• Cashiers, rather than supervisors, have access to the controls necessary for refunds and voids.
• Cashiers are authorized to void their own transactions.
• Register refunds are not carefully reviewed.
• Multiple cashiers operate from a single cash drawer without separate access codes.
• Personal checks from cashiers are found in the cash register.
• Voided transactions are not properly documented or approved by a supervisor.
• Voided cash receipt forms (manual systems) or supporting documents for voided transactions (cash register systems) are not retained on file.
• There are gaps in the transaction numbers on the register log.
• There are excessive refunds, voids, or no-sales on the register log.
• Inventory totals appear forced.
• There are multiple refunds or voids for amounts just under the review limit.

Question 35

The debt-to-equity ratio is computed by dividing current liabilities by total equity.

A. True
B. False

Answer 35

B. False

See pages 1.246 in the Fraud Examiner’s Manual

The debt-to-equity ratio is computed by dividing total liabilities by total equity. This financial leverage ratio is one that is heavily considered by lending institutions. It provides a better understanding of the comparison between the long-term and short-term debt of the company and the owner’s financial injection plus earnings to date. Debt-to-equity requirements are often included as borrowing covenants in corporate lending agreements.

Question 36

Which of the following statements about the methods used to make corrupt payments in corruption schemes is INCORRECT?

A. Payers often make corrupt payments by making outright payments falsely described as innocent loans.
B. Payers often make corrupt payments by selling property to recipients at prices higher than the property’s market value.
C. Payers often make corrupt payments by using their credit cards to pay recipients’ transportation, vacation, and entertainment expenses.
D. Payers often make corrupt payments by buying assets from recipients and allowing the recipients to retain title or use of the items.

Answer 36

B. Payers often make corrupt payments by selling property to recipients at prices higher than the property’s market value.

See pages 1.610 in the Fraud Examiner’s Manual

Corrupt payments often take the form of loans. There are three types of loans often found in corruption cases:

• An outright payment that is falsely described as an innocent loan
• A legitimate loan in which a third party—the corrupt payer—makes or guarantees payments to satisfy the loan
• A legitimate loan made on favorable terms (e.g., an interest-free loan)

A corrupt payment can be in the form of credit card use or payments toward a party’s credit card debt. The payer might use a credit card to pay a recipient’s transportation, vacation, or entertainment expenses, or the payer might pay off a recipient’s credit card debt. In some instances, the recipient might carry and use the corrupt payer’s credit card.

Corrupt payments also might come in the form of promises of favorable treatment. In addition, corrupt payments might occur in the form of transfers for a value other than fair market. In such transfers, the corrupt payer might sell or lease property to the recipient at a price that is less than its market value, or the payer might agree to buy or rent property from the recipient at an inflated price. The recipient might also “sell” an asset to the payer but retain the title or use of the property.

Question 37

The removal of cash from a victim organization before the cash is entered in the organization’s accounting system is:

A. A fraudulent disbursement
B. Cash larceny
C. Skimming
D. Lapping

Answer 37

C. Skimming

See pages 1.301 in the Fraud Examiner’s Manual

Skimming is the removal of cash from a victim entity prior to its entry in an accounting system. Employees who skim from their companies steal sales or receivables before they are recorded in the company books. Because of this aspect of their nature, skimming schemes are known as off-book frauds; they leave no direct audit trail.

Question 38

Reconciling the cash register total to the amount of cash in the drawer is an ineffective method of detecting a cash larceny scheme.

A. True
B. False

Answer 38

B. False

See pages 1.321, 1.329-1.330 in the Fraud Examiner’s Manual

In contrast to skimming schemes, the register records should not match up with the cash in the drawer when a cash larceny scheme has occurred. For this reason, cash larceny schemes are much easier to detect than skimming schemes because they leave an audit trail. To detect a cash larceny scheme, one recommended practice is to perform independent reconciliations of the register totals to the amount of cash in the drawer.

Question 39

Which of the following financial statement manipulations is NOT a type of improper asset valuation scheme?

A. Booking of fictitious assets
B. Recording expenses in the wrong period
C. Overstated accounts receivable
D. Inflated inventory valuation

Answer 39

B. Recording expenses in the wrong period

See pages 1.222 in the Fraud Examiner’s Manual

Most improper asset valuations involve the fraudulent overstatement of inventory or receivables, with the goal being to strengthen the appearance of the balance sheet and/or certain financial ratios. Other improper asset valuations include manipulation of the allocation of the purchase price of an acquired business to inflate future earnings, misclassification of fixed and other assets, or improper capitalization of inventory or start-up costs.

Improper asset valuations usually take the form of one of the following classifications:

• Inventory valuation
• Accounts receivable
• Business combinations
• Fixed assets

Question 40

Fraud in financial statements generally takes the form of overstated assets or revenue and understated liabilities and expenses.

A. True
B. False

Answer 40

A. True

See pages 1.208 in the Fraud Examiner’s Manual

Fraud in financial statements takes the form of overstated assets or revenue and understated liabilities and expenses. Overstating assets or revenue falsely reflects a financially stronger company by the inclusion of fictitious asset costs or artificial revenues. Understated liabilities and expenses are shown through the exclusion of costs or financial obligations. Both methods result in increased equity and net worth for the company. This overstatement and/or understatement results in increased earnings per share or partnership profit interests or a more stable representation of the company’s financial situation.

Question 41

White, an employee of ABC Corporation, intentionally issued two payments for the same invoice. After the checks had been mailed, White called the vendor and explained that a double payment had been made by mistake. White asked the vendor to return one of the checks to her attention. When the vendor returned the check, White took it and cashed it. This is an example of a:

A. Receivables skimming scheme
B. Pay and return scheme
C. Shell company scheme
D. Pass-through scheme

Answer 41

B. Pay and return scheme

See pages 1.442 in the Fraud Examiner’s Manual

Instead of using shell companies in their overbilling schemes, some employees generate fraudulent disbursements by using the invoices of legitimate third-party vendors who are not a part of the fraud scheme. In a pay and return scheme, an employee intentionally mishandles payments that are owed to legitimate vendors. One way to do this is to purposely pay an invoice twice. For instance, a clerk might intentionally pay an invoice twice and then call the vendor to request that one of the checks be returned. The clerk then intercepts the returned check.

Question 42

Both falsely increasing the perpetual inventory balance and failing to reconcile inventory records are ways a fraudster might conceal inventory shrinkage.

A. True
B. False

Answer 42

B. False

See pages 1.510 in the Fraud Examiner’s Manual

Falsely increasing the perpetual inventory record would only worsen the shrinkage problem. Instead, a fraudster seeking to conceal shrinkage would falsely decrease the perpetual inventory record to match the lower physical inventory count. In addition, failing to reconcile inventory records would likely cause more suspicion to arise.

One of the simplest methods for concealing shrinkage is to change the perpetual inventory record so that it matches the physical inventory count. This is also known as a forced reconciliation of the account. The perpetrator simply changes the numbers in the perpetual inventory to make them match the amount of inventory that is available. For example, the employee might credit (decrease) the perpetual inventory and debit (increase) the cost of the sales account to lower the perpetual inventory numbers so that they match the actual inventory count. Instead of using correct entries to adjust the perpetual inventory, some employees simply delete or cover up the correct totals and enter new numbers.

Question 43

Of the following, who should conduct physical observations of a company’s inventory to MOST EFFECTIVELY prevent inventory theft?

A. The purchasing agent
B. The purchasing supervisor
C. An internal auditor
D. Warehouse personnel

Answer 43

C. An internal auditor

See pages 1.517 in the Fraud Examiner’s Manual

Someone independent of the purchasing or warehousing functions should conduct physical observation of inventory. The personnel conducting the physical observations should also be knowledgeable about the inventory. For example, internal auditors are responsible for assessing a company’s business processes, but they typically have no access to the physical inventory, which makes them plausible candidates to conduct physical observations of a company’s inventory.

Question 44

The asset turnover ratio is calculated by dividing net sales by average total assets.

A. True
B. False

Answer 44

A. True

See pages 1.247 in the Fraud Examiner’s Manual

The asset turnover ratio is used to determine the efficiency with which assets are used during the period. The asset turnover ratio is typically calculated by dividing net sales by average total assets (net sales / average total assets). However, average operating assets can also be used as the denominator (net sales / average operating assets).

Question 45

The method of concealing a receivables skimming scheme whereby one customer account is credited for a payment that was intended for another account is called which of the following?

A. Lapping
B. Currency substitution
C. Altered payee designation
D. Inventory padding

Answer 45

A. Lapping

See pages 1.313 in the Fraud Examiner’s Manual

Lapping customer payments is one of the most common methods used to conceal skimming. It is a technique that is particularly useful to employees who skim receivables. Lapping is the crediting of one account through the abstraction of money from another account.

For example, suppose a company has three customers: A, B, and C. When A’s payment is received, the fraudster steals it instead of posting it to A’s account. Customer A expects that their account will be credited with the payment they have made, but this payment has actually been stolen. When A’s next statement arrives, A will see that the payment was not applied to their account and will complain. To avoid this, some action must be taken to make it appear that the payment was posted. When B’s payment arrives, the fraudster takes this money and posts it to A’s account. Payments now appear to be up to date on A’s account, but B’s account remains unpaid. When C’s payment is received, the perpetrator applies it to B’s account.

Question 46

Sheila, an accounts payable supervisor for ABC Company, bought supplies for a company she owns on the side. Sheila entered vouchers in ABC’s accounts payable system for the cost of the supplies so that ABC would pay for the supplies. The supplies were then drop-shipped to a location where Sheila could collect them. What type of occupational fraud is this?

A. An expense reimbursement scheme
B. A pay and return scheme
C. An invoice kickback scheme
D. A personal purchases with company funds scheme

Answer 46

D. A personal purchases with company funds scheme

See pages 1.443-1.444 in the Fraud Examiner’s Manual

Instead of undertaking billing schemes to generate cash, many fraudsters purchase personal items with their company’s money. Company accounts are used to buy items for employees, their businesses, or their families. This type of scheme is classified as a fraudulent billing scheme rather than theft of inventory. The basis of the scheme is not the theft of the items but rather the purchase of them. The perpetrator causes the victim company to purchase something it did not need, so the damage to the company is the money lost in purchasing the item.

Question 47

When an employee or official uses force or fear to demand money in exchange for making a particular business decision, that individual is engaging in:

A. Bribery
B. An illegal gratuity scheme
C. Economic extortion
D. A kickback scheme

Answer 47

C. Economic extortion

See pages 1.608 in the Fraud Examiner’s Manual

Extortion is defined as the obtaining of property from another, with the other party’s consent induced by wrongful use of actual or threatened force or fear. Economic extortion is present when an employee or official, through the wrongful use of actual or threatened force or fear, demands money or some other consideration to make a particular business decision. Thus, an example of an economic extortion scheme is if an employee or government official demands money in exchange for making a business decision. Similarly, another example of an economic extortion scheme would be if a politician threatens to close a business if it does not pay a bribe.

Question 48

Most shell company schemes involve the purchase of fictitious:

A. Services
B. Inventory
C. Supplies
D. Goods

Answer 48

A. Services

See pages 1.441 in the Fraud Examiner’s Manual

Most shell company schemes involve the purchase of services rather than goods. The primary reason for this is that services are not tangible. If an employee sets up a shell company to make fictitious sales of goods to their employer, these goods will obviously never arrive. By comparing its purchases to its inventory levels, the victim organization might detect the fraud. It is much more difficult for the victim organization to verify that the services were never rendered. For this reason, many employees involved in shell company schemes bill their employers for “consulting services.”

Question 49

The asset turnover ratio is used to assess a company’s ability to meet sudden cash requirements.

A. True
B. False

Answer 49

B. False

See pages 1.244, 1.247-1.248 in the Fraud Examiner’s Manual

The asset turnover ratio (net sales divided by average total assets) is used to determine the efficiency with which asset resources are used by the entity. The asset turnover ratio is one of the more reliable indicators of financial statement fraud. A sudden or continuing decrease in this ratio is often associated with improper capitalization of expenses, which increases the denominator without a corresponding increase in the numerator.

The quick ratio is used to assess a company’s ability to meet sudden cash requirements. The quick ratio, commonly referred to as the acid test ratio, compares quick assets (i.e., those that can be immediately liquidated) to current liabilities. It is calculated by dividing the total of cash, securities, and receivables by current liabilities. The quick ratio offers a more conservative view of a company’s liquidity because it excludes inventory and other current assets that are more difficult to turn into cash rapidly.

Question 50

Which of the following is NOT a type of loan that frequently turns up in corruption cases?

A. A legitimate loan in which a third party makes the loan payments
B. An outright payment falsely described as an innocent loan
C. A legitimate loan made at market rates
D. A legitimate loan made on favorable terms

Answer 50

C. A legitimate loan made at market rates

See pages 1.610 in the Fraud Examiner’s Manual

Corrupt payments often take the form of loans. There are three types of loans often found in corruption cases:

• An outright payment that is falsely described as an innocent loan
• A legitimate loan in which a third party—the corrupt payer—makes or guarantees payments to satisfy the loan
• A legitimate loan made on favorable terms (e.g., an interest-free loan)

A legitimate loan made at market rates would not typically occur in a corruption case because the loan recipient would not be receiving anything unusual or special.

Question 51

Cash theft schemes fall into which of the following two categories?

A. Skimming and unrecorded sales
B. Unrecorded sales and false discounts
C. Register manipulation and understated sales
D. Skimming and cash larceny

Answer 51

D. Skimming and cash larceny

See pages 1.301 in the Fraud Examiner’s Manual

Cash theft schemes fall into two categories: skimming and cash larceny. The difference between the two types of schemes depends completely on when the cash is stolen. Cash larceny is the theft of money that has already appeared on a victim organization’s books, while skimming is the theft of cash that has not been recorded in the accounting system. The way in which an employee extracts the cash might be exactly the same for a cash larceny or skimming scheme.

Question 52

Traditionally, there are two methods of percentage analysis of financial statements. They are:

A. Balance sheet and income statement analysis
B. Horizontal and historical analysis
C. Vertical and historical analysis
D. Horizontal and vertical analysis

Answer 52

D. Horizontal and vertical analysis

See pages 1.241 in the Fraud Examiner’s Manual

Traditionally, there are two methods of percentage analysis of financial statements. Vertical analysis is a technique for analyzing the relationships among the items on an income statement, balance sheet, or statement of cash flows during a specific accounting period by expressing components as percentages of a specified base value within the statement being analyzed. Horizontal analysis is a technique for analyzing the percentage change in individual line items on a financial statement from one accounting period to the next. The first period in the analysis is considered the base period, and the changes to subsequent periods are computed as a percentage of the base period.

Question 53

Jessica worked at the cash register of a department store. Her friend Molly came to the store one day to help Jessica steal a watch she wanted but could not afford. Molly took the watch to Jessica’s register and, instead of charging Molly for it, Jessica performed a No-Sale transaction on the register. Molly pretended to give Jessica cash to make it look like she was paying for the watch. Molly then took the watch out of the store and later gave it to Jessica. What type of scheme did Molly and Jessica commit?

A. A register disbursement scheme
B. A purchasing and receiving scheme
C. A skimming scheme
D. A false sale scheme

Answer 53

D. A false sale scheme

See pages 1.505 in the Fraud Examiner’s Manual

In many cases, corrupt employees use outside accomplices to help steal inventory. The false, or fake, sale is one method that depends upon an accomplice. Like most inventory thefts, the fake sale is not complicated. The employee-fraudster’s accomplice pretends to buy merchandise, but the employee does not record the sale. The accomplice then takes the merchandise without paying for it. To a casual observer, it will appear that the transaction is a normal sale. The employee places the merchandise in a bag and acts as though a transaction is being entered on the register when in actuality the sale is not recorded. The accomplice might even pass a nominal amount of money to the employee to complete the illusion. A related scheme occurs when an employee sells merchandise to an accomplice at an unauthorized discount.

Question 54

Failing to record bad debt expense for the period will result in overstated accounts receivable.

A. True
B. False

Answer 54

A. True

See pages 1.223-1.224 in the Fraud Examiner’s Manual

Managers can overstate their company’s accounts receivable balance by failing to record bad debt expense. Bad debt expense is recorded to account for any uncollectible accounts receivable. The debit side of the entry increases bad debt expense, and the credit side of the entry increases the allowance (or provision) for doubtful accounts, which is a contra account that is recorded against accounts receivable. Therefore, if the controller fails to record bad debt expense, the allowance (or provision) for doubtful accounts will be understated.

Question 55

Management has an obligation to disclose all events and transactions in the financial statements that are probable to have a material effect on the entity’s financial position.

A. True
B. False

Answer 55

A. True

See pages 1.232 in the Fraud Examiner’s Manual

Accounting principles require that financial statements include all the information necessary to prevent a reasonably discerning user of the financial statements from being misled. Disclosures only need to include events and transactions that have or are probable to have a material impact on the entity’s financial position.

Question 56

Which of the following does NOT happen in a fictitious refund scheme?

A. Merchandise is returned to the stock room.
B. A fraudster processes a transaction as if a customer were returning merchandise.
C. The register log balances with the amount of money in the register.
D. The company’s inventory is overstated.

Answer 56

A. Merchandise is returned to the stock room.

See pages 1.403 in the Fraud Examiner’s Manual

In a fictitious refund scheme, an employee processes a transaction as if a customer were returning merchandise, even though no actual return takes place. There are two results of this fraudulent transaction. First, the employee takes cash from the register in the amount of the false return. Since the register log shows that a merchandise return has been made, the disbursement appears legitimate. The register log balances with the amount of money in the register because the money that was taken by the employee is supposed to have been removed and given to a customer as a refund.

The second repercussion is that a debit is made to the inventory system showing that the merchandise has been returned to the inventory. Because the transaction is fictitious, no merchandise is returned. As a result, the company’s inventory is overstated.

Question 57

Pass-through schemes are usually undertaken by employees who receive inventory on behalf of the victim company.

A. True
B. False

Answer 57

B. False

See pages 1.441 in the Fraud Examiner’s Manual

Pass-through schemes are usually undertaken by employees who oversee purchasing on behalf of the victim company. Instead of buying merchandise directly from a vendor, the employee sets up a shell company and purchases the merchandise through that fictitious entity. They then resell the merchandise to their employer from the shell company at an increased price, thereby making an unauthorized profit on the transaction.

Question 58

How does vertical analysis differ from horizontal analysis?

A. Vertical analysis expresses the percentage of component items to a specific base item while horizontal analysis analyzes the percentage change in individual line items on a financial statement from one accounting period to the next.
B. Vertical analysis compares the performance of a parent company to its subsidiary while horizontal analysis compares different companies throughout a particular industry.
C. Vertical analysis compares items on one financial statement to items on a different financial statement while horizontal analysis compares items on the same financial statement.
D. Vertical analysis is a means of measuring the relationship between any two different financial statement amounts while horizontal analysis examines the relationship between specific financial statement ratios.

Answer 58

A. Vertical analysis expresses the percentage of component items to a specific base item while horizontal analysis analyzes the percentage change in individual line items on a financial statement from one accounting period to the next.

See pages 1.241, 1.243 in the Fraud Examiner’s Manual

Vertical analysis is a technique for analyzing the relationships among the items on an income statement, balance sheet, or statement of cash flows during a specific accounting period by expressing components as percentages of a specified base value within the statement being analyzed. Horizontal analysis is a technique for analyzing the percentage change in individual line items on a financial statement from one accounting period to the next. Ratio analysis is a means of measuring the relationship between any two different financial statement amounts. The relationship and comparison are the keys to any of these types of financial analyses.

Question 59

Horizontal analysis is a technique for analyzing the relationships among the items on an income statement, balance sheet, or statement of cash flows during a specific accounting period by expressing components as percentages of a specified base value within the statement being analyzed.

A. True
B. False

Answer 59

B. False

See pages 1.241, 1.243 in the Fraud Examiner’s Manual

Horizontal analysis is a technique for analyzing the percentage change in individual line items on a financial statement from one accounting period to the next. The first period in the analysis is considered the base period, and the changes in the subsequent period are computed as a percentage of the base period.

Vertical analysis is a technique for analyzing the relationships among the items on an income statement, balance sheet, or statement of cash flows during a specific accounting period by expressing components as percentages of a specified base value within the statement being analyzed. Ratio analysis is a means of measuring the relationship between any two different financial statement amounts. The relationship and comparison are the keys to any of these types of financial analyses.

Question 60

_______________ is a system by which the bank verifies checks presented for payment against the list provided by the company of approved checks written on the account.

A. Payment patrol
B. Check matching
C. Positive pay
D. Verification control

Answer 60

C. Positive pay

See pages 1.432 in the Fraud Examiner’s Manual

Positive pay allows a company and its bank to work together to detect fraudulent items presented for payment. The company provides the bank with a list of checks and amounts that are written each day. The bank verifies items presented for payment against the company’s list and rejects items that are not on the list. Investigations are conducted as to the origin of the unlisted items.

Question 61

Which of the following methods would be useful in detecting a ghost employee scheme?

A. Comparing personnel records to payroll data
B. Analyzing payroll withholdings
C. Examining payroll checks for dual endorsements
D. All of the above

Answer 61

D. All of the above

See pages 1.469-1.470 in the Fraud Examiner’s Manual

Comparing personnel records maintained by the human resources (HR) department to payroll data can be useful in detecting ghost employee schemes. An analysis of payroll withholdings might also reveal either ghost employees or trust account abuses. Ghost employees will often have no withholding taxes, insurance, or other normal deductions. Therefore, a listing of any employee without these items might reveal a ghost employee. Another way to detect a ghost employee scheme is to examine paychecks for dual endorsements. This might indicate that the fraudster has forged an endorsement to deposit the ghost’s paychecks into the fraudster’s account.

Question 62

A fraud scheme in which an accountant fails to write down obsolete inventory to its current fair market value has what effect on the company’s current ratio?

A. The current ratio will be artificially inflated.
B. The current ratio will be artificially deflated.
C. The current ratio will not be affected.
D. It is impossible to determine.

Answer 62

A. The current ratio will be artificially inflated.

See pages 1.221 in the Fraud Examiner’s Manual

Many schemes are used to inflate current assets at the expense of long-term assets. In the case of such schemes, 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. By misclassifying long-term assets as short-term, the current ratio will appear artificially stronger. This type of misclassification can be of critical concern to lending institutions that often require certain financial ratio minimums to be maintained. This is of particular consequence when the loan covenants are on unsecured or under-secured lines of credit and other short-term borrowings. Sometimes these misclassifications are referred to as window dressing.

Question 63

Jill is an accountant who needs to satisfy continuing professional education (CPE) requirements to maintain her professional license. Her supervisor usually signs these requests without paying them much attention, which Jill decides to use to her advantage. Jill realizes that it would be easy to copy the image of the logo from a popular CPE provider and generate a receipt using basic computer software. She creates a fraudulent receipt and submits it to her supervisor for reimbursement. What type of scheme is Jill committing?

A. A mischaracterized expense scheme
B. A multiple reimbursement scheme
C. Collusion with a supervisor
D. A fictitious expense scheme

Answer 63

D. A fictitious expense scheme

See pages 1.478 in the Fraud Examiner’s Manual

Expense reimbursements are sometimes sought by employees for fictitious items. Instead of overstating a real business expense or seeking reimbursement for a personal expense, an employee invents a purchase to request reimbursement. One way to generate a reimbursement for a fictitious expense is to create fraudulent support documents, such as false receipts. Using basic computer software, it is easy for employees to create realistic-looking counterfeit receipts. These counterfeits are often very sophisticated, even including logos of the stores in which the goods or services were allegedly purchased.

Question 64

ABC Company purchases a material amount of products from another entity whose operating policies can be controlled by ABC Company’s management, but it does not disclose this situation on its financial statements. In which type of improper disclosure scheme has ABC Company engaged?

A. Significant event
B. Improper asset valuation
C. Accounting change
D. Related-party transaction

Answer 64

D. Related-party transaction

See pages 1.233-1.234 in the Fraud Examiner’s Manual

Related-party transactions are business deals or arrangements between two parties who hold a pre-existing connection prior to the transaction. These transactions generally occur when a company does business with another entity whose management or operating policies can be controlled or significantly influenced by the company or by some other party in common. There is nothing inherently wrong with related-party transactions if they are fully disclosed. If the transactions are not fully disclosed, the company might injure its shareholders by engaging in economically harmful dealings without their knowledge. The financial interest that a company official might have might not be readily apparent. For example, common directors of two companies that do business with each other, any corporate general partner and the partnerships with which it does business, and any controlling shareholder of the corporation with which they do business may be related parties. Family relationships can also be considered related parties, such as all direct descendants and ancestors, without regard to financial interests. Related-party transactions are sometimes referred to as self-dealing.

Question 65

Which of the following is TRUE regarding the methods typically used for making corrupt payments in corruption schemes?

A. Payers often make corrupt payments by offering recipients loans on extremely favorable terms
B. Payers often make corrupt payments by paying off the recipient’s credit card debt
C. Payers often make corrupt payments by selling property to recipients at prices lower than the property’s market value
D. All of the above

Answer 65

D. All of the above

See pages 1.610 in the Fraud Examiner’s Manual

Corrupt payments often take the form of loans. There are three types of loans often found in corruption cases:

• An outright payment that is falsely described as an innocent loan
• A legitimate loan in which a third party—the corrupt payer—makes or guarantees payments to satisfy the loan
• A legitimate loan made on favorable terms (e.g., an interest-free loan)

A corrupt payment can be in the form of credit card use or payments toward a party’s credit card debt. The payer might use a credit card to pay a recipient’s transportation, vacation, or entertainment expenses, or the payer might pay off a recipient’s credit card debt. In some instances, the recipient might carry and use the corrupt payer’s credit card.

Corrupt payments also might come in the form of promises of favorable treatment. In addition, corrupt payments might occur in the form of transfers for a value other than fair market. In such transfers, the corrupt payer might sell or lease property to the recipient at a price that is less than its market value, or the payer might agree to buy or rent property from the recipient at an inflated price. The recipient might also “sell” an asset to the payer but retain the title or use of the property.

Question 66

A fraudster can understate expenses and their related liabilities to make a company appear more profitable than it is.

A. True
B. False

Answer 66

A. True

See pages 1.227 in the Fraud Examiner’s Manual

Understating liabilities and expenses is one of the ways financial statements can be manipulated to make a company appear more profitable. Because pre-tax income will increase by the full amount of the expense or liability not recorded, this financial statement fraud method can significantly affect reported earnings with relatively little effort by the fraudster. There are three common methods for concealing liabilities and expenses:

• Omitting liabilities and/or expenses
• Improperly capitalizing costs rather than expensing them
• Failing to disclose warranty costs and product-return liabilities

Question 67

Which of the following is a method of committing a falsified hours and salary scheme?

A. Forging a supervisor’s signature
B. Altering a time sheet after it has been approved
C. Colluding with a supervisor
D. All of the above

Answer 67

D. All of the above

See pages 1.461-1.465 in the Fraud Examiner’s Manual

The most common method of misappropriating funds from the payroll is the overpayment of wages. For hourly employees, the size of a paycheck is based on two factors: the number of hours worked and the rate of pay. Therefore, for hourly employees to fraudulently increase the size of their paycheck, they must either falsify the number of hours they have worked or change their wage rate.

Common ways to commit a falsified hours and salary scheme include:

• Inflating the number of hours worked
• Inflating the rate of pay
• Forging a supervisor’s signature
• Collusion with a supervisor
• Implementing poor custody procedures
• Altering a time sheet after it has been approved

Question 68

Financial statement fraud is the intentional or erroneous misrepresentation of the financial condition of an enterprise.

A. True
B. False

Answer 68

B. False

See pages 1.203 in the Fraud Examiner’s Manual

Financial statement fraud is the deliberate misrepresentation of the financial condition of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users. Financial statement fraud, much like all types of fraud, is an intentional act.

Question 69

An analytical review reveals that Rollins Company’s cost of goods sold increased by 80% last year. Its sales, however, only increased by 40%. What might this discrepancy indicate?

A. There were fewer sales this year versus last year.
B. Inventory has been depleted by theft.
C. The quantity of items purchased decreased.
D. There were more sales returns this year than in the prior year.

Answer 69

B. Inventory has been depleted by theft.

See pages 1.513 in the Fraud Examiner’s Manual

Inventory fraud might be detected by using an analytical review because certain trends become immediately clear. For example, sales and cost of goods sold should move together since they are directly related. However, if the cost of goods sold increases by a disproportionate amount in relation to sales and there have been no changes to the purchase prices, quantities purchased, or quality of products purchased, then the cause of the disproportionate increase in cost of goods sold might be one of three things: (1) ending inventory has been depleted by theft, (2) someone has been embezzling money through a false billing scheme, or (3) someone has been skimming sales revenue.

Question 70

Which financial ratio is calculated by dividing current assets by current liabilities?

A. Profit margin
B. Receivable turnover
C. Quick ratio
D. Current ratio

Answer 70

D. Current ratio

See pages 1.244 in the Fraud Examiner’s Manual

The current ratio—current assets divided by current liabilities—is one of the most-used liquidity ratios in financial statement analysis. This comparison measures a company’s ability to meet present obligations from its liquid assets; specifically, the current ratio measures the amount of times current assets would be able to pay back current liabilities. In detecting fraud, this ratio can be a prime indicator of manipulation of accounts involved.

Embezzlement will cause the ratio to decrease. Liability concealment will cause a more favorable ratio.

Question 71

The person who is responsible for shipping inventory should also be responsible for converting inventory to scrap.

A. True
B. False

Answer 71

B. False

See pages 1.517 in the Fraud Examiner’s Manual

Separation of duties is among the measures commonly used to prevent inventory theft. Different personnel should be responsible for the following duties:

• Requisition of inventory
• Receipt of inventory
• Disbursement/shipment of inventory
• Conversion of inventory to scrap
• Receipt of proceeds from disposal of scrap

Question 72

Which of the following is NOT a method that is used to conceal inventory shrinkage?

A. Selling merchandise without recording the sale
B. Writing off stolen inventory as scrap
C. Placing empty boxes on warehouse shelves
D. Performing a forced reconciliation of the inventory records

Answer 72

A. Selling merchandise without recording the sale

See pages 1.510-1.512 in the Fraud Examiner’s Manual

Some fraudsters try to make it appear as though there are more assets present in the warehouse or stockroom than there actually are by physically padding the inventory. Empty boxes or boxes filled with bricks or other inexpensive materials, for example, might be stacked on shelves to create the illusion of extra inventory. In one case, employees stole liquor from their stockroom and restacked the containers for the missing merchandise. This made it appear that the missing inventory was present when in actuality there were empty boxes on the stockroom shelves.

One of the simplest methods for concealing shrinkage is to decrease the perpetual inventory record so that it matches the physical inventory count. This is also known as a forced reconciliation of the account. Basically, the perpetrator just changes the numbers in the perpetual inventory to make them match the amount of inventory that is available.

Writing off inventory as obsolete, damaged, or unsellable is also a relatively common way for fraudsters to remove assets from the books before or after they are stolen. This is beneficial to the fraudster because it eliminates the problem of shrinkage that inherently exists in every case of noncash asset misappropriation.

Selling merchandise without recording the sale would actually increase the amount of shrinkage on a company’s books because the physical inventory would be depleted without a corresponding adjustment to the perpetual inventory.

Question 73

A company must disclose potential losses from ongoing litigation only if the related liability is probable to result in a future obligation.

A. True
B. False

Answer 73

A. True

See pages 1.233 in the Fraud Examiner’s Manual

Contingent liabilities are potential obligations that will materialize only if certain events occur in the future. A corporate guarantee of personal loans received by a company officer and potential losses from ongoing litigation are examples of contingent liabilities that must be disclosed. Current accounting standards require entities to disclose contingent liabilities in the notes to the financial statements if it is reasonably possible that an outflow of cash will be required to settle a present obligation in the future.

Question 74

Events occurring after the close of the period that could have a significant effect on the entity’s financial position must be disclosed in the entity’s financial statements.

A. True
B. False

Answer 74

A. True

See pages 1.233 in the Fraud Examiner’s Manual

Events occurring or becoming known after the close of the period that could have a significant effect on the entity’s financial position must be disclosed. Fraudsters typically avoid disclosing court judgments and regulatory decisions that undermine the reported values of assets, that indicate unrecorded liabilities, or that adversely reflect upon management’s integrity. A review of subsequent financial statements, if available, might reveal whether management improperly failed to record a subsequent event that it had knowledge of in the previous financial statements. Public record searches can also help reveal this information.

Question 75

Which of the following is considered misuse of a noncash asset?

A. Olivia had access to a company vehicle while working in a different city. She used the vehicle to run some personal errands after she was finished with work for the day, but she provided false written and oral information regarding her use of the vehicle.
B. Mike works for a lawn care service. One of his customers lives on his street. After Mike finishes mowing the customer’s lawn, he uses his employer’s lawnmower to mow his own lawn.
C. Lisa is a paralegal, but she also works as a personal fitness trainer on the weekends. She stays after work at the law office one day to print invoices for her personal training clients.
D. All of the above are considered misuses of noncash assets.

Answer 75

D. All of the above are considered misuses of noncash assets.

See pages 1.501 in the Fraud Examiner’s Manual

There are two ways a person can misappropriate a company asset: the asset can be misused (or “borrowed”) or stolen. Assets that are misused but not stolen typically include company vehicles, supplies, computers, and other office equipment. For example, suppose an employee made personal use of a company vehicle while working in a different city. The employee provided false information, both written and verbal, regarding the use of the vehicle. The vehicle was returned without damages and the cost to the perpetrator’s company was only a few hundred dollars. Despite the modest financial impact, such unauthorized use of a company asset constitutes fraud, particularly when a false statement accompanies the use.

Question 76

Bruce is a purchaser for Acme Widgets. Bruce’s brother-in-law is a salesperson for Olson Electronics, one of Acme’s largest suppliers. Bruce told his supervisor about the relationship, and she approved his ordering of supplies from his brother-in-law, provided that the purchases were reviewed by a senior manager. Bruce did not receive any favors or money from his brother-in-law in return for the sales. A year after Bruce discussed the situation with his supervisor, Acme’s management discovers that another supplier offers the same parts as Olson Electronics but at a cheaper price. Acme Widgets is considering suing Bruce for conflict of interest. Which of the following is the MOST ACCURATE statement about Acme’s chances of success?

A. Acme’s chances are good because it could have gotten the supplies at a lower price.
B. Acme’s chances are poor because Bruce did not actually receive any money from his brother-in-law for sending him business.
C. Acme’s chances are good because it is clear that Bruce had a conflict of interest in dealing with his brother-in-law.
D. Acme’s chances are poor because the company was aware of the situation and allowed Bruce to do business with his brother-in-law’s company despite the relationship.

Answer 76

D. Acme’s chances are poor because the company was aware of the situation and allowed Bruce to do business with his brother-in-law’s company despite the relationship.

See pages 1.627-1.629 in the Fraud Examiner’s Manual

A conflict of interest occurs when an employee or agent—someone who is authorized to act on behalf of a principal—has an undisclosed personal or economic interest in a matter that could influence their professional role. But to be classified as a conflict of interest scheme, the employee’s interest in the transaction must be undisclosed. The crux of a conflict case is that the fraudster takes advantage of their employer; the victim organization is unaware that its employee has divided loyalties. If an employer knows of the employee’s interest in a business deal or negotiation, there can be no conflict of interest, no matter how favorable the arrangement is for the employee.

Question 77

Which of the following is a common reason why people commit financial statement fraud?

A. To cover inability to generate cash flow
B. To encourage investment through the sale of stock
C. To demonstrate compliance with loan covenants
D. All of the above

Answer 77

D. All of the above

See pages 1.204-1.205 in the Fraud Examiner’s Manual

Unlike some other types of fraud (such as embezzlement), the motivation for financial statement fraud does not always involve personal gain. Most commonly, financial statement fraud is used to make a company’s earnings appear better than they are. Financial statement fraud occurs through a variety of methods, such as valuation judgments and manipulating the timing of transaction recording. These more subtle types of fraud are often dismissed as either mistakes or errors in judgment and estimation. Some of the more common reasons why people commit financial statement fraud include:

• To encourage investment through the sale of stock
• To demonstrate increased earnings per share or partnership profits interest, thus allowing increased dividend/distribution payouts
• To cover inability to generate cash flow
• To avoid negative market perceptions
• To obtain financing or to obtain more favorable terms on existing financing
• To receive higher purchase prices for acquisitions
• To demonstrate compliance with financing covenants
• To meet company goals and objectives
• To receive performance-related bonuses

Question 78

When investigating whether financial statements have been manipulated to make a company appear more profitable, a Certified Fraud Examiner (CFE) should look for liabilities that have been overstated.

A. True
B. False

Answer 78

B. False

See pages 1.227 in the Fraud Examiner’s Manual

Understating liabilities and expenses is one of the ways financial statements can be manipulated to make a company appear more profitable. Because pre-tax income will increase by the full amount of the expense or liability not recorded, this financial statement fraud method can significantly affect reported earnings with relatively little effort by the fraudster. There are three common methods for concealing liabilities and expenses:

• Omitting liabilities and/or expenses
• Improperly capitalizing costs rather than expensing them
• Failing to disclose warranty costs and product-return liabilities

Question 79

James is a purchaser for a large government entity. ABC Inc. tells James that if he awards ABC at least $5 million in contracts over the next two years, then ABC will hire James at the end of the two years at twice his current salary. Because no actual money changes hands, this could NOT be considered a bribery or corruption scheme.

A. True
B. False

Answer 79

B. False

See pages 1.601, 1.610 in the Fraud Examiner’s Manual

Bribes do not necessarily involve direct payments of cash or goods. Bribery may be defined as the offering, giving, receiving, or soliciting of corrupt payments—items of value paid to procure a benefit contrary to the rights of others—to influence an official act or business decision. Promises of favorable treatment can constitute corrupt payments. Such promises commonly take the following forms:

• A payer might promise a government official lucrative employment when the recipient leaves government service.
• An executive who resigns from a private company and takes a related government position might be given favorable or inflated retirement and separation benefits.
• The spouse or other relative of the intended recipient might also be employed by the payer company at an inflated salary or with minimal actual responsibility.

Question 80

Which of the following is a red flag of register disbursement schemes?

A. Personal checks from cashiers are found in the cash register
B. There are multiple refunds or voids just under the review limit
C. Voided transactions are not properly documented or approved by a supervisor
D. All of the above

Answer 80

D. All of the above

See pages 1.409 in the Fraud Examiner’s Manual

Red flags of register disbursement schemes include the following:

• There is inappropriate separation of duties for employees.
• Cashiers, rather than supervisors, have access to the controls necessary for refunds and voids.
• Cashiers are authorized to void their own transactions.
• Register refunds are not carefully reviewed.
• Multiple cashiers operate from a single cash drawer without separate access codes.
• Personal checks from cashiers are found in the cash register.
• Voided transactions are not properly documented or approved by a supervisor.
• Voided cash receipt forms (manual systems) or supporting documents for voided transactions (cash register systems) are not retained on file.
• There are gaps in the transaction numbers on the register log.
• There are excessive refunds, voids, or no-sales on the register log.
• Inventory totals appear forced.
• There are multiple refunds or voids for amounts just under the review limit.

Question 81

Elena Smith, a city commissioner, negotiated a land development deal with a group of private investors. After the deal was approved, the investors rewarded Elena with an all-expenses-paid trip even though giving such rewards to government officials is prohibited by law. Which of the following is the MOST APPROPRIATE term to describe what has taken place?

A. Economic extortion
B. Need recognition
C. Illegal gratuity
D. Collusion

Answer 81

C. Illegal gratuity

See pages 1.607 in the Fraud Examiner’s Manual

Illegal gratuities are items of value given to reward a decision, often after the recipient has made the decision. Illegal gratuities are similar to bribery schemes except that, unlike bribery schemes, illegal gratuity schemes do not necessarily involve an intent to influence a particular decision before the fact. That is, an illegal gratuity occurs when an item of value is given for, or because of, some act. Often, an illegal gratuity is merely something that a party who has benefited from a decision offers as an underhanded thank-you to the person who made the beneficial decision.

Question 82

Which of the following is a means of measuring the relationship between any two different financial statement amounts?

A. Relational comparison
B. Ratio analysis
C. Transaction detail analysis
D. Statement comparison

Answer 82

B. Ratio analysis

See pages 1.243 in the Fraud Examiner’s Manual

Ratio analysis is a means of measuring the relationship between any two different financial statement amounts. The relationship and comparison are the keys to the analysis, which allows for internal evaluations using financial statement data. Traditionally, financial statement ratios are used in comparisons to an entity’s industry average. They can be very useful in detecting red flags for a fraud examination.

Question 83

James runs an electronics store. One of the main challenges in his business is keeping up with technological advances. Because of this, his auditors want to ensure inventory is not fraudulently overstated on the store’s balance sheet. Which of the following actions should the auditors take to ensure inventory is NOT overstated?

A. View the inventory and conduct a physical count
B. Ensure that inventory is recorded at the lower of cost or net realizable value
C. Ensure that James has written off obsolete inventory
D. All of the above

Answer 83

D. All of the above

See pages 1.222-1.223 in the Fraud Examiner’s Manual

Under many countries’ accounting standards, including U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), inventory must be recorded at the lower of cost, market value, or net realizable value, depending on the inventory costing method used. This means that inventory must be valued at its acquisition cost, except when the cost is determined to be higher than the net realizable value, in which case the difference should be recognized as a loss in earnings in the period it occurs. Failing to write down or write off inventory results in overstated assets and the mismatching of cost of goods sold with revenues.

Other methods by which inventory can be improperly stated include manipulation of the physical inventory count, inflation of the unit costs used to price out inventory, and failure to adjust inventory for the costs of goods sold. Fictitious inventory schemes usually involve the creation of fake documents, such as inventory count sheets and receiving reports.

In some instances, friendly co-conspirators claim to be holding inventory for companies in question. Other times, companies falsely report large values of inventory in transit, knowing that it would be nearly impossible for the auditors to observe. When possible, fraud examiners should perform a physical inventory count, checking to make sure the inventory exists as described in the records. There have been cases of fraudsters assembling pallets of inventory with hollow centers, placing bricks in sealed boxes instead of high-value products, and moving inventory overnight between locations.

Question 84

___________________ is the unaccounted-for reduction in a company’s inventory that results from error or theft.

A. Depreciation
B. Shortness
C. Defalcation
D. Shrinkage

Answer 84

D. Shrinkage

See pages 1.510 in the Fraud Examiner’s Manual

Inventory shrinkage is the unaccounted-for reduction in the company’s inventory that results from error or theft. For instance, assume a computer retailer has 1,000 computers in stock. After work one day, an employee loads 200 computers into a truck and takes them home. Now the company only has 800 computers, but since there is no record that the employee took any of the computers, the inventory records still show that 1,000 computers are available. The company has experienced inventory shrinkage in the amount of 200 computers.

Question 85

Julia, a fraud examiner, is performing tests to look for potential asset misappropriation schemes at her company. One of her routine tests is to compare the payroll records to the human resources (HR) files. What type of fraud scheme is she MOST LIKELY looking for when performing this test?

A. A fraudulent commissions scheme
B. A check tampering scheme
C. A ghost employee scheme
D. A falsified hours and wages scheme

Answer 85

C. A ghost employee scheme

See pages 1.456, 1.470 in the Fraud Examiner’s Manual

Comparing personnel records maintained by the human resources (HR) department to payroll data can be useful in detecting ghost employee schemes. The term ghost employee refers to someone on the payroll who does not work for the victim company. Through the falsification of personnel or payroll records, a fraudster causes paychecks to be generated to a nonemployee, or ghost.

For example, comparing employee names, addresses, government identification numbers, and bank account numbers can determine if there are any unexpected duplicates or discrepancies that would indicate a ghost on the payroll.

Question 86

A detailed expense report should require which of the following components?

A. Time period when the expense occurred
B. Original receipts (when possible)
C. Explanation of the business purpose of each expense
D. All of the above

Answer 86

D. All of the above

See pages 1.482 in the Fraud Examiner’s Manual

Detailed expense reports should require the following information:

• Receipts or other support documentation
• Explanation of the expense, including specific business purpose
• Time period when the expense occurred
• Place of expenditure
• Amount

When possible, require employees to submit original paper receipts. Given the amount of electronic and internet commerce that occurs, this is not always possible. Electronic copies of receipts are often much easier to forge and alter than paper receipts. Special attention should be paid to any receipts that come via email or email attachment. Consider corroborating prices on internet receipts with those found on the vendor’s website.

It is not enough to have the detailed reports submitted if they are not reviewed. A policy requiring the periodic review of expense reports, coupled with examining the appropriate detail, will help deter employees from submitting personal expenses for reimbursement.

Question 87

All the following are types of expense reimbursement schemes EXCEPT:

A. Multiple reimbursements
B. Ghost expense reports
C. Fictitious expenses
D. Mischaracterized expenses

Answer 87

B. Ghost expense reports

See pages 1.473 in the Fraud Examiner’s Manual

The four main types of expense reimbursement schemes are:

• Mischaracterized expenses
• Overstated expenses
• Fictitious expenses
• Multiple reimbursements

There is no such scheme as ghost expense reports. Ghost employees, however, are a common payroll fraud scheme.

Question 88

All the following are classifications of billing schemes EXCEPT:

A. Bid rigging
B. Personal purchases with company funds
C. Shell company schemes
D. Invoicing via nonaccomplice vendors

Answer 88

A. Bid rigging

See pages 1.436 in the Fraud Examiner’s Manual

There are three principal types of billing schemes:

• Invoicing via shell companies
• Invoicing via nonaccomplice vendors
• Personal purchases with company funds

Question 89

Skimming schemes can involve the theft of cash sales or the theft of accounts receivable payments.

A. True
B. False

Answer 89

A. True

See pages 1.301 in the Fraud Examiner’s Manual

Skimming is the removal of cash from a victim entity prior to its entry in an accounting system. Employees who skim from their companies steal sales or accounts receivable payments before they are recorded in the company books.

Question 90

Which of the following control procedures will NOT help prevent payroll fraud?

A. Keeping the payroll accounting function independent of the general ledger function
B. Prenumbering payroll checks and issuing them in numerical sequence
C. Having the employee who prepares the payroll also review and sign all payroll checks
D. Maintaining personnel records separately from payroll and timekeeping functions

Answer 90

C. Having the employee who prepares the payroll also review and sign all payroll checks

See pages 1.470 in the Fraud Examiner’s Manual

There are two basic preventive measures for payroll-related fraud: separation of duties and periodic payroll review and analysis. The following activities should be separated:

• Payroll preparation
• Payroll disbursement (into payroll and withholding tax accounts)
• Payroll distribution
• Payroll bank reconciliations
• Human resources (HR) departmental functions

Therefore, the employee who prepares the payroll should not review or sign any payroll checks.

Question 91

Which of the following is the CORRECT calculation of the quick ratio?

A. (Cash + receivables) / current liabilities
B. (Cash + marketable securities) / accounts payable
C. (Cash + marketable securities + receivables) / current liabilities
D. Current assets / current liabilities

Answer 91

C. (Cash + marketable securities + receivables) / current liabilities

See pages 1.244 in the Fraud Examiner’s Manual

The quick ratio, commonly referred to as the acid test ratio, compares quick assets (i.e., those that can be immediately liquidated) to current liabilities. This ratio is a measure of a company’s ability to meet sudden cash requirements. It is important to note that while the current ratio includes inventory in its current assets, the quick ratio does not. Thus, the quick ratio offers a more conservative view of a company’s liquidity because it excludes inventory and other current assets that are more difficult to turn into cash rapidly. The quick ratio can be determined with the following equation: quick ratio = (cash + marketable securities + receivables) / current liabilities.

Question 92

Which of the following would be helpful in detecting a skimming scheme?

A. Examining journal entries for false credits to inventory
B. Confirming customers’ unpaid account balances
C. Examining journal entries for accounts receivable write-offs
D. All of the above

Answer 92

D. All of the above

See pages 1.318 in the Fraud Examiner’s Manual

Skimming can sometimes be detected by reviewing and analyzing all journal entries made to the cash and inventory accounts. Journal entries involving the following topics should be examined:

• Credits to inventory to conceal unrecorded or understated sales
• Write-offs of lost, stolen, or obsolete inventory
• Write-offs of accounts receivable accounts
• Irregular entries to cash accounts

Confirmation of customers’ accounts is another method that might detect skimming schemes that involve lapping. In a receivables skimming scheme, the fraudster skims a customer’s payment instead of posting it to the customer’s account. The next payment that arrives gets posted to the skimming victim’s account, and so on. Therefore, in a skimming scheme, at least one customer account will appear delinquent on the books, even though that customer has paid.

Question 93

Which of the following statements is TRUE regarding a fictitious refund scheme?

A. The amount of cash in the register balances with the register log
B. The victim company’s inventory is understated
C. Inventory is returned to the store
D. All of the above

Answer 93

A. The amount of cash in the register balances with the register log

See pages 1.403 in the Fraud Examiner’s Manual

In a fictitious refund scheme, an employee processes a transaction as if a customer were returning merchandise, even though no actual return takes place. The register log balances with the amount of cash in the register because the money that was taken by the fraudster is supposed to have been removed and given to the customer as a refund. Instead, however, the employee keeps this cash.

Also, a debit is made to the inventory system showing that the merchandise has been returned. Since the transaction is fictitious, no merchandise is returned. The result is that the company’s inventory is overstated.

Question 94

Kickbacks are improper, undisclosed payments made to obtain favorable treatment.

A. True
B. False

Answer 94

A. True

See pages 1.602-1.603 in the Fraud Examiner’s Manual

Kickbacks are improper, undisclosed payments made to obtain favorable treatment. For example, in a kickback scheme, an employee might receive compensation in exchange for directing excess business to a vendor. Such compensation could involve monetary payments, entertainment, travel, or other favorable perks.

Question 95

Which of the following would be considered a timing difference financial statement fraud scheme?

A. Recognizing revenue in Year 1 when the service is performed, even though the customer doesn’t have to pay until Year 2
B. Recognizing a percentage of revenue on a construction project corresponding to the percentage of the project that is complete
C. Waiting to record revenue on a contract until a construction job is complete
D. Recording revenue in Year 1 when the payment is received, even though the service won’t be performed until Year 2

Answer 95

D. Recording revenue in Year 1 when the payment is received, even though the service won’t be performed until Year 2

See pages 1.215-1.220 in the Fraud Examiner’s Manual

Financial statement fraud often involves timing differences—that is, the recording of revenues or expenses in improper periods. This can be done to move revenues or expenses between one period and the next, increasing or decreasing earnings as desired. This practice is also referred to as income smoothing.

Examples of timing difference fraud schemes include:

• Premature revenue recognition—In general, revenue is recognized when (or as) an entity satisfies a performance obligation by transferring a promised good or service (asset) to a customer. Consequently, even if the seller has received payment for a service, revenue cannot be recognized until the service has been performed, thus satisfying the performance obligation.
• Long-term contracts—In some jurisdictions, revenue on long-term contracts can be recognized under one of two methods. The completed-contract method does not record revenue until the project is 100% complete. The percentage-of-completion method, conversely, recognizes revenues and expenses in proportion to what percentage of the project is complete.
• Recording expenses in the wrong period—Per the matching principle, expenses must be recognized in the same period as the corresponding revenues. The timely recording of expenses is sometimes compromised due to pressures to meet budget projections and goals.

Question 96

Darla is an accounts receivable clerk at Richmond Storage Rental. Carson, who rents one of the company’s storage units, submits his monthly payment to Richmond’s office. Instead of applying the payment to Carson’s account, Darla takes the money and keeps it for herself. The next payment that arrives comes from Fisher. Instead of applying Fisher’s payment to the correct account, Darla applies it to Carson’s account so that it does not appear delinquent. The next payment that arrives gets applied to Fisher’s account, and Darla continues to apply incoming customer payments to the previous customer’s account so that no one discovers her initial theft of Carson’s payment. What type of scheme is Darla committing?

A. Kiting
B. Substitution
C. Lapping
D. Padding

Answer 96

C. Lapping

See pages 1.313 in the Fraud Examiner’s Manual

Lapping customer payments is one of the most common methods used to conceal skimming. It is a technique that is particularly useful to employees who skim receivables. Lapping is the crediting of one account through the abstraction of money from another account.

For example, suppose a company has three customers: A, B, and C. When A’s payment is received, the fraudster steals it instead of posting it to A’s account. Customer A expects that their account will be credited with the payment they have made, but this payment has actually been stolen. When A’s next statement arrives, A will see that the payment was not applied to their account and will complain. To avoid this, some action must be taken to make it appear that the payment was posted. When B’s payment arrives, the fraudster takes this money and posts it to A’s account. Payments now appear to be up to date on A’s account, but B’s account remains unpaid. When C’s payment is received, the perpetrator applies it to B’s account.

Question 97

Pam is the purchasing manager at a retail store. She decides to form a shell company and purchase merchandise through this entity. She then sells the merchandise to her employer at an increased price as if she were a legitimate vendor. What type of scheme is Pam committing?

A. A pass-through scheme
B. A pay and return scheme
C. A need recognition scheme
D. A cash larceny scheme

Answer 97

A. A pass-through scheme

See pages 1.441 in the Fraud Examiner’s Manual

Pass-through schemes are usually undertaken by employees who oversee purchasing on behalf of the victim company. Instead of buying merchandise directly from a vendor, the employee sets up a shell company and purchases the merchandise through that fictitious entity. They then resell the merchandise to their employer from the shell company at an increased price, thereby making an unauthorized profit on the transaction.

Question 98

Bruce, a manager for a retail store, suspects his cashiers of skimming sales. Bruce will be able to detect this kind of scheme by comparing their register totals to the amount of money in their cash drawers.

A. True
B. False

Answer 98

B. False

See pages 1.302 in the Fraud Examiner’s Manual

When an employee skims money by making off-book sales of merchandise, it is impossible to detect theft by comparing the register to the cash drawer because the sale was not recorded on the register.

Question 99

A ____________ scheme involves the theft of cash BEFORE it has been recorded on a company’s books, and a __________ scheme involves the theft of cash AFTER it has already appeared on the books.

A. Cash larceny; revenue
B. Cash larceny; skimming
C. Skimming; cash larceny
D. Fraudulent disbursement; skimming

Answer 99

C. Skimming; cash larceny

See pages 1.301 in the Fraud Examiner’s Manual

Cash receipts schemes fall into two categories: skimming and larceny. Cash larceny is the theft of money that has already appeared on a victim organization’s books, while skimming is the theft of cash that has not been recorded in the accounting system.

Question 100

Which of the following is recommended to prevent fraud in electronic payments?

A. Applying ACH blocks and filters
B. Positive pay for ACH transactions
C. Having separate bank accounts for paper checks and electronic payment
D. All of the above

Answer 100

D. All of the above

See pages 1.434-1.435 in the Fraud Examiner’s Manual

Most large banks offer multiple security services that can help business account holders mitigate fraud through early detection and prevention of fraudulent electronic payments. For example, automated clearing house (ACH) blocks allow account holders to notify their banks that ACH debits should not be allowed on specific accounts. ACH filters enable account holders to provide their banks with a list of defined criteria against which banks can filter ACH debits and reject any unauthorized transactions. Positive pay for ACH is another security feature offered by banks to their account holders. With positive pay, banks match the details of ACH payments with those on a list of legitimate and expected payments provided by the account holder. Only authorized electronic transactions are allowed to be withdrawn from the account; exceptions are reported to the customer for review.

Companies should consider segregating their bank accounts to maintain better control over them—for example, separate accounts can be used for paper and electronic transactions. Having separate bank accounts will facilitate the audit process and help the fraud examiner identify any electronic payments that seem suspicious.

Question 101

Which of the following scenarios is an example of a conflict of interest?

A. An employee for a phone installation company works as a fishing guide on weekends but does not tell the phone company about the other job.
B. An employee has an undisclosed personal relationship with a company that does business with their employer.
C. An employee for a pharmaceutical company has an economic interest in a company that does business with their employer and discloses it to their employer.
D. An employee is related to someone who works for one of their company’s vendors and informs their employer of the relationship.

Answer 101

B. An employee has an undisclosed personal relationship with a company that does business with their employer.

See pages 1.627-1.629 in the Fraud Examiner’s Manual

A conflict of interest occurs when an employee or agent—someone who is authorized to act on behalf of a principal—has an undisclosed personal or economic interest in a matter that could influence their professional role. Thus, an employee with an undisclosed personal relationship with a company that does business with their employer is engaged in a conflict of interest. An employee who has an undisclosed side job would not be engaged in a conflict of interest, provided that the job is in a different industry, does not create a time conflict, and does not create any personal or economic interest that could influence their ability to act in their primary employer’s best interest.

Most conflicts of interest occur because the fraudster has an undisclosed economic interest in a transaction, but a conflict can exist when the fraudster’s hidden interest is not economic. In some scenarios, an employee acts in a manner detrimental to their company to provide a benefit to a friend or relative even though the fraudster receives no financial benefit.

Conflicts of interest do not necessarily constitute legal violations, if they are properly disclosed. Thus, to be classified as a conflict of interest scheme, the employee’s interest in the transaction must be undisclosed. The crux of a conflict case is that the fraudster takes advantage of their employer; the victim organization is unaware that its employee has divided loyalties. If an employer knows of the employee’s interest in a business deal or negotiation, there can be no conflict of interest, no matter how favorable the arrangement is for the employee.

Question 102

Failure to record corresponding revenues and expenses in the same accounting period will result in an understatement of net income in the period when the revenue is recorded and an overstatement of net income in the period when the corresponding expenses are recorded.

A. True
B. False

Answer 102

B. False

See pages 1.220 in the Fraud Examiner’s Manual

According to generally accepted accounting principles (GAAP), revenue and corresponding expenses should be recorded or matched in the same accounting period. The timely recording of expenses is often compromised due to pressures to meet budget projections and goals or due to lack of proper accounting controls. As the expensing of certain costs is pushed into periods other than the ones in which they occur, they are not properly matched against the income that they help produce. For example, revenue might be recognized on the sale of certain items, but the cost of goods and services that went into the items sold might not be recorded intentionally in the accounting system until the following period. This might make the sales revenue from the transaction almost pure profit, inflating earnings. In the next period, earnings would have fallen by a similar amount.

Question 103

The warehouse supervisor at South Corp. has stolen $50,000 worth of inventory over the last year and has made no effort to conceal the theft in any of the inventory records. However, a physical inventory reconciliation was performed at the end of the year by accounting staff. During an analytical review of the financial statements, which of the following red flags might South Corp.’s auditors find that would indicate the inventory theft?

A. The percentage change in cost of goods sold was significantly higher than the percentage change in sales.
B. Sales and cost of goods sold moved together.
C. The percentage change in sales was significantly higher than the percentage change in cost of goods sold.
D. None of the above possible outcomes would indicate inventory theft.

Answer 103

A. The percentage change in cost of goods sold was significantly higher than the percentage change in sales.

See pages 1.513 in the Fraud Examiner’s Manual

Inventory fraud might be detected by using an analytical review because certain trends become immediately clear. For example, sales and cost of goods sold should move together since they are directly related. However, if the cost of goods sold increases by a disproportionate amount in relation to sales and there have been no changes to the purchase prices, quantities purchased, or quality of products purchased, then the cause of the disproportionate increase in cost of goods sold might be one of three things: (1) ending inventory has been depleted by theft, (2) someone has been embezzling money through a false billing scheme, or (3) someone has been skimming sales revenue.

Question 104

Daniela, a plant manager for a utility company, also owns a commercial cleaning business. Daniela threatened to withhold business from any vendors of the utility company that did not hire her cleaning business for their office cleaning needs. Which of the following BEST describes the type of corruption scheme in which Daniela engaged?

A. Kickback scheme
B. Collusion scheme
C. Illegal gratuity scheme
D. Economic extortion scheme

Answer 104

D. Economic extortion scheme

See pages 1.608 in the Fraud Examiner’s Manual

Extortion is defined as the obtaining of property from another, with the other party’s consent induced by wrongful use of actual or threatened force or fear. Economic extortion is present when an employee or official, through the wrongful use of actual or threatened force or fear, demands money or some other consideration to make a particular business decision. Thus, because Daniela threatened to withhold business from any vendors of the utility company that did not hire her cleaning business for their office cleaning needs, she engaged in an extortion scheme.

Question 105

Examples of expense reimbursement schemes include which of the following?

A. Requesting reimbursement for an expense that was never incurred
B. Listing personal travel as business travel
C. Listing dinner with a friend as a business development expense
D. All of the above

Answer 105

D. All of the above

See pages 1.473 in the Fraud Examiner’s Manual

Employees can manipulate an organization’s expense reimbursement procedures to generate fraudulent disbursements. The four most common types of expense reimbursement schemes are mischaracterized expenses, overstated expenses, fictitious expenses, and multiple reimbursements.

Question 106

For employee expense reimbursement requests, electronic receipts are preferred to paper receipts because they are more difficult to alter or forge.

A. True
B. False

Answer 106

B. False

See pages 1.482 in the Fraud Examiner’s Manual

Requiring employees to submit receipts electronically is not a recommended form of expense reimbursement fraud prevention. In fact, electronic receipts are often much easier to forge or alter than paper receipts.

Question 107

The quick ratio is used to determine the efficiency with which a company uses its assets.

A. True
B. False

Answer 107

B. False

See pages 1.244, 1.247 in the Fraud Examiner’s Manual

The quick ratio, commonly referred to as the acid test ratio, compares quick assets (i.e., those that can be immediately liquidated) to current liabilities. This calculation divides the total of cash, securities, and receivables by current liabilities to yield a measure of a company’s ability to meet sudden cash requirements. The quick ratio offers a more conservative view of a company’s liquidity because it excludes inventory and other current assets that are more difficult to turn into cash rapidly.

The asset turnover ratio is used to determine the efficiency with which asset resources are used by the entity.

Question 108

If employees are aware that surprise cash counts are conducted, then they will generally be less inclined to commit a cash larceny scheme.

A. True
B. False

Answer 108

A. True

See pages 1.332-1.333 in the Fraud Examiner’s Manual

Surprise cash counts and supervisory observations can be useful fraud prevention methods. It is important that employees know that cash will be counted on a periodic and unscheduled basis. These surprise counts must be made at all steps of the process, from receiving the check, to reconciling the register log to the cash in the drawer, to depositing funds in the bank.

Question 109

Gaps in the transaction numbers on the register log might indicate that a register disbursement scheme is taking place.

A. True
B. False

Answer 109

A. True

See pages 1.409 in the Fraud Examiner’s Manual

Red flags of register disbursement schemes include the following:

• There is inappropriate separation of duties for employees.
• Cashiers, rather than supervisors, have access to the controls necessary for refunds and voids.
• Cashiers are authorized to void their own transactions.
• Register refunds are not carefully reviewed.
• Multiple cashiers operate from a single cash drawer without separate access codes.
• Personal checks from cashiers are found in the cash register.
• Voided transactions are not properly documented or approved by a supervisor.
• Voided cash receipt forms (manual systems) or supporting documents for voided transactions (cash register systems) are not retained on file.
• There are gaps in the transaction numbers on the register log.
• There are excessive refunds, voids, or no-sales on the register log.
• Inventory totals appear forced.
• There are multiple refunds or voids for amounts just under the review limit.

Question 110

Katie is a salesclerk at a jewelry store. She watched Helen, another salesclerk, type her access code into her register and Katie memorized it. When Helen called in sick, Katie logged in to the cash register using Helen’s code and processed customer transactions as usual. After completing one sale, she left the drawer open and slipped a large sum of money into her pocket from the register drawer. What type of scheme did she commit?

A. A skimming scheme
B. An understated sales scheme
C. A cash larceny scheme
D. A register disbursement scheme

Answer 110

C. A cash larceny scheme

See pages 1.307, 1.323, 1.401 in the Fraud Examiner’s Manual

In some retail organizations, there is one cash register, and each employee has a different access code. By using someone else’s access code to enter the register and then steal cash under their name, the perpetrator makes sure that another employee will be the prime suspect in the theft. Katie’s theft was not a skimming scheme because the cash she stole was already in the company’s possession and recorded in the register. An understated sales scheme is a type of skimming scheme in which a fraudster records a sale for less than it actually is and skims the difference.

Katie did not commit a register disbursement scheme because register disbursement schemes involve a fraudulent transaction that justifies the removal of cash from the register, such as a false return or a voided sale. Katie did not make any entry that would account for the missing money—she took money out of the register under Helen’s name so that she could avoid blame. Therefore, Katie committed a cash larceny scheme.

Question 111

Laura, the sales manager of Sam Corp., is afraid sales revenue for the period is not going to meet company goals. To compensate for the shortfall, she decides to mail invoices to fake customers and credit (increase) revenue on the books for these sales. What account will she MOST LIKELY debit to balance these fictitious revenue entries and conceal her scheme?

A. Inventory
B. Cash
C. Accounts payable
D. Accounts receivable

Answer 111

D. Accounts receivable

See pages 1.212 in the Fraud Examiner’s Manual

Fictitious or fabricated revenues involve the recording of sales of goods or services that did not occur. Fictitious sales most often involve fake customers but can also involve legitimate customers. At the end of the accounting period, the sale will be reversed (as will all revenue accounts), which will help to conceal the fraud.

Recording the sales revenue is easy, but the challenge for the fraudster is how to balance the other side of the entry. A credit to revenue increases the revenue account, but the corresponding debit in a legitimate sales transaction typically either goes to cash or accounts receivable. Because no cash is received in a fictitious revenue scheme, increasing accounts receivable is the easiest way to get away with completing the entry. Unlike revenue accounts, however, accounts receivable are not reversed at the end of the accounting period. They stay on the books as an asset until collected. If the outstanding accounts are never collected, they will eventually need to be written off as bad debt expense. Mysterious accounts receivable on the books that are long overdue are a common sign of a fictitious revenue scheme.

Question 112

Which of the following is NOT an effective control to protect against skimming schemes?

A. Reconciling the physical inventory count with the perpetual inventory records
B. Installing visible video cameras to monitor a store’s cash registers
C. Reconciling the sales records to the cash receipts
D. Restricting the accounts receivable clerk from preparing the bank deposit

Answer 112

C. Reconciling the sales records to the cash receipts

See pages 1.319-1.320 in the Fraud Examiner’s Manual

Since skimming is an off-book fraud, routine account reconciliation is not likely to prevent or detect a skimming scheme. If such a scheme is taking place, reconciling the sales records to the amount of cash received will not indicate there is anything amiss; because the skimmed sale was never recorded, the books will remain in balance. Reconciling the physical inventory count with the perpetual inventory records, however, might reveal that there is shrinkage and therefore a skimming scheme.

As with most fraud schemes, internal control procedures are a key to the prevention of skimming schemes. For instance, employees who have access to the cash register should not also be responsible for delivering the bank deposit. The accounts receivable clerk should be restricted from preparing the bank deposit, accessing the accounts receivable journal, and having access to collections from customers.

An essential part of developing control procedures is management’s communication to employees. Controlling whether an employee will not record a sale, understate a sale, or steal incoming payments is extremely difficult. Some physical controls can be put in place to prevent employee skimming, such as video cameras monitoring employees who handle cash and the implementation of a lockbox.

Question 113

Sales and cost of goods sold almost always move together unless there have been changes to purchase prices, quantities purchased, or quality of products being purchased.

A. True
B. False

Answer 113

A. True

See pages 1.513 in the Fraud Examiner’s Manual

Inventory fraud might be detected by using an analytical review because certain trends become immediately clear. For example, sales and cost of goods sold should move together since they are directly related. However, if the cost of goods sold increases by a disproportionate amount in relation to sales and there have been no changes to the purchase prices, quantities purchased, or quality of products purchased, then the cause of the disproportionate increase in cost of goods sold might be one of three things: (1) ending inventory has been depleted by theft, (2) someone has been embezzling money through a false billing scheme, or (3) someone has been skimming sales revenue.

Question 114

Sean is responsible for delivering time sheets to the payroll department on behalf of his supervisor. One day he decides to withhold his time sheet from those being sent to his supervisor for approval. He falsely increases the number of hours he has worked and then forges his supervisor’s signature on his time sheet. He adds the time sheet to the stack of authorized sheets and delivers them to payroll. This is an example of:

A. A check tampering scheme
B. A fictitious reimbursement scheme
C. A falsified hours and salary scheme
D. A ghost employee scheme

Answer 114

C. A falsified hours and salary scheme

See pages 1.461-1.465 in the Fraud Examiner’s Manual

For hourly employees, the size of a paycheck is based on two essential factors: the number of hours worked and the rate of pay. Therefore, for hourly employees to fraudulently increase the size of their paycheck, they must either falsify the number of hours they have worked or change their wage rate. One form of control breakdown that is common in falsified hours and salary schemes is the failure to maintain proper control over time cards. In a proper system, once time cards are authorized by management, they should be sent directly to payroll. Those who prepare the time cards should not have access to them after they have been approved. When this procedure is not observed, the person who prepared a time card can alter it after that person’s supervisor has approved it but before it is delivered to payroll.

Common ways to commit a falsified hours and salary scheme include:

• Inflating the number of hours worked
• Inflating the rate of pay
• Forging a supervisor’s signature
• Collusion with a supervisor
• Implementing poor custody procedures
• Altering a time sheet after it has been approved

Question 115

Vertical analysis can BEST be described as a technique for analyzing the percentage change in individual line items on a financial statement from one accounting period to the next.

A. True
B. False

Answer 115

B. False

See pages 1.241, 1.243 in the Fraud Examiner’s Manual

Vertical analysis is a technique for analyzing the relationships among the items on an income statement, balance sheet, or statement of cash flows during a specific accounting period by expressing components as percentages of a specified base value within the statement being analyzed. Horizontal analysis is a technique for analyzing the percentage change in individual line items on a financial statement from one accounting period to the next. Ratio analysis is a means of measuring the relationship between any two different financial statement amounts. The relationship and comparison are the keys to any of these types of financial analyses.

Question 116

There are two methods for recognizing revenue on long-term construction contracts. Which of the following is one of those methods?

A. Cost-to-completion method
B. Contract-valuation method
C. Percentage-of-completion method
D. Partial-contract method

Answer 116

C. Percentage-of-completion method

See pages 1.219 in the Fraud Examiner’s Manual

Long-term contracts can cause problems for revenue recognition. In some jurisdictions, for example, revenues and expenses from long-term construction contracts can be recorded using either the completed-contract method or the percentage-of-completion method, depending on the circumstances. The completed contract method does not record revenue until the project is 100% complete. The percentage-of-completion method, conversely, recognizes revenues and expenses in proportion to what percentage of the project is complete. This method is particularly vulnerable to manipulation because managers can falsify the percentage of completion and the estimated costs to complete a construction project to recognize revenues prematurely and conceal contract overruns.

Question 117

Tanya, a cash register attendant at a department store, regularly inflates the amount of customer refunds. For instance, if a customer returns an item for $100, Tanya records a $150 refund. Then Tanya gives the customer $100 and keeps $50 for herself. This scheme is known as:

A. A fictitious refund scheme
B. Skimming
C. A false void scheme
D. An overstated refund scheme

Answer 117

D. An overstated refund scheme

See pages 1.403-1.404 in the Fraud Examiner’s Manual

One type of register disbursement scheme is the overstated refund. Rather than creating an entirely fictitious refund, a fraudster might overstate the value of a real customer’s refund, pay the customer the actual amount owed for the returned merchandise, and then keep the excess portion of the return.

In a fictitious refund scheme, an employee processes a transaction as if a customer were returning merchandise, even though there is no actual return. Then the employee takes cash from the register in the amount of the false return. The customer might or might not be aware of the scheme taking place.

Fictitious voids are similar to refund schemes in that they make fraudulent disbursements from the register appear to be legitimate. To process a false void, the perpetrator first needs the customer’s copy of the sales receipt. Typically, when an employee sets about processing a fictitious void, the employee withholds the customer’s receipt at the time of the sale. In many cases, customers do not notice that they are not given a receipt.

Skimming is the removal of cash from a victim entity prior to its entry in an accounting system.

Question 118

Which of the following is a common reason why someone might commit financial statement fraud?

A. To obtain favorable terms on financing
B. To misuse company assets
C. To attempt to get a coworker fired
D. To harm a competitor’s reputation

Answer 118

A. To obtain favorable terms on financing

See pages 1.204-1.205 in the Fraud Examiner’s Manual

Unlike some other types of fraud (such as embezzlement), the motivation for financial statement fraud does not always involve personal gain. Most commonly, financial statement fraud is used to make a company’s earnings appear better than they are. Financial statement fraud occurs through a variety of methods, such as valuation judgments and manipulating the timing of transaction recording. These more subtle types of fraud are often dismissed as either mistakes or errors in judgment and estimation. Some of the more common reasons why people commit financial statement fraud include:

• To encourage investment through the sale of stock
• To demonstrate increased earnings per share or partnership profits interest, thus allowing increased dividend/distribution payouts
• To cover inability to generate cash flow
• To avoid negative market perceptions
• To obtain financing or to obtain more favorable terms on existing financing
• To receive higher purchase prices for acquisitions
• To demonstrate compliance with financing covenants
• To meet company goals and objectives
• To receive performance-related bonuses

Question 119

The accounts receivable clerk should be responsible for both collecting cash and disbursing company funds.

A. True
B. False

Answer 119

B. False

See pages 1.332 in the Fraud Examiner’s Manual

The primary means of preventing cash fraud is separation of duties. Whenever one individual has control over the entire accounting transaction (e.g., authorization, recording, and custody), the opportunity is present for cash fraud. Each of the following duties/responsibilities should be separated:

• Cash receipts
• Bank deposits
• Bank reconciliations
• Cash disbursements

If one person has the authority to collect the cash, deposit the receipts, record that collection, and disburse company funds, the risk of fraud is high.

Question 120

Electronic payment tampering is generally easier to detect than traditional check tampering because it leaves a clear audit trail.

A. True
B. False

Answer 120

B. False

See pages 1.434 in the Fraud Examiner’s Manual

Electronic payment tampering is generally more difficult to detect than traditional check tampering schemes. As with other schemes, once the fraudulent payment has been made, the employee must cover their tracks. However, the lack of physical evidence and forged signatures can make concealment of fraudulent electronic payments less challenging than other check tampering schemes. Some fraudsters attempt to conceal their schemes by altering the bank statement, miscoding transactions in the accounting records, or sending fraudulent payments to a shell company with a name similar to that of an existing vendor. Others merely rely on the company’s failure to monitor or reconcile its accounts.

Question 121

Green, a door-to-door salesperson, sold several appliances to households in a neighborhood. Green took the money the customers gave him as down payments for the sales and spent it. He did not turn in the orders to his employer. Green’s scheme can BEST be classified as:

A. An understated sales (skimming) scheme
B. A cash larceny scheme
C. A commission scheme
D. An unrecorded sales (skimming) scheme

Answer 121

D. An unrecorded sales (skimming) scheme

See pages 1.302, 1.307 in the Fraud Examiner’s Manual

Green’s scheme is an unrecorded sales (skimming) scheme. An unrecorded sales scheme occurs when an employee sells goods or services to a customer and collects the customer’s payment but makes no record of the sale.

Independent salespersons are in a good position to perform sales skimming schemes. A prime example is a person who sells goods door to door but does not turn in the orders to their employer. In this case, Green did not remit any of his sales to the appliance company, so the skimming scheme that took place was an unrecorded sales scheme.

In a typical understated sales (skimming) scheme, an employee enters or submits a sales total that is lower than the amount paid by the customer and skims the difference between the actual purchase price of the item and the sales figure recorded.

Question 122

Joe formed a company called Glenn Corp. He opened a bank account in Glenn Corp.’s name and used his home computer to create fraudulent invoices from Glenn Corp. for “consulting services.” However, Glenn Corp. is a fictitious entity that was created solely to commit fraud, and no services were rendered. Joe mailed these invoices to his employer, Paisley Company. Paisley Company promptly submitted payment to Glenn Corp., not realizing that the company was fake, and Joe deposited the money. What type of billing scheme did Joe commit?

A. A pass-through scheme
B. A cash larceny scheme
C. A shell company scheme
D. A pay and return scheme

Answer 122

C. A shell company scheme

See pages 1.436, 1.439 in the Fraud Examiner’s Manual

Shell companies, though sometimes created for legitimate purposes, are often fictitious entities created for the sole purpose of committing fraud. They might be nothing more than a fabricated name and address that an employee uses to collect disbursements from false billings. However, since the checks received are made in the name of the shell company, the perpetrator normally also sets up a bank account in their shell company’s name. Once a shell company has been formed and a bank account has been opened, the corrupt employee begins billing their employer by mailing forged invoices for fictitious goods or services.

Question 123

For a ghost employee scheme involving an hourly employee to be successful, all the following must happen EXCEPT:

A. The ghost employee must be a fictitious person.
B. A paycheck must be issued to the ghost employee.
C. Timekeeping information must be collected for the ghost employee.
D. The ghost employee must be added to the payroll.

Answer 123

A. The ghost employee must be a fictitious person.

See pages 1.456 in the Fraud Examiner’s Manual

For a ghost employee scheme to work, there must be four components: (1) the ghost must be added to the payroll, (2) timekeeping (for an hourly employee) and wage rate information must be collected, (3) a paycheck must be issued to the ghost, and (4) the check must be delivered to the perpetrator or an accomplice. The ghost employee might be a fictitious person or a real individual who does not work for the victim employer. When the ghost is a real person, they are often the perpetrator’s friend or relative. In some cases, the ghost employee is an accomplice of the fraudster who cashes the fraudulent paychecks and splits the money with the perpetrator.

Question 124

Anna works as a cashier in an antiques store. Since the merchandise lacks bar codes, she must enter the prices manually. One customer purchased a piece of furniture that cost $250 and paid with cash. Anna recorded the sale at $200 and kept the extra $50. What type of fraud did Anna commit?

A. Lapping of receivables
B. An understated sales (skimming) scheme
C. A cash larceny scheme
D. An unrecorded sales (skimming) scheme

Answer 124

B. An understated sales (skimming) scheme

See pages 1.302, 1.307 in the Fraud Examiner’s Manual

Understated sales schemes are commonly undertaken by employees who work at the cash register. In a typical scheme, an employee enters a sales total that is lower than the amount paid by the customer. The employee skims the difference between the actual purchase price of the item and the sales figure recorded on the register. In this case, the item was sold for $250, but Anna recorded the sale of a $200 item and skimmed the excess $50.

Rather than reduce the price of an item, an employee might record the sale of fewer items. If one hundred units are sold, for instance, an employee might only record the sale of fifty units and skim the excess amount paid for the additional fifty units.

An unrecorded sales scheme occurs when an employee sells goods or services to a customer and collects the customer’s payment but makes no record of the sale.

Question 125

_____________________ is the deliberate misrepresentation of the financial condition of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users.

A. Financial statement fraud
B. Material misstatement
C. Accounting fraud
D. Occupational fraud

Answer 125

A. Financial statement fraud

See pages 1.203 in the Fraud Examiner’s Manual

Financial statement fraud is the deliberate misrepresentation of the financial condition of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users.

Question 126

Brittany, a cash register teller, logged onto her register, performed a No-Sale transaction to open the drawer, and then removed a large sum of money. Which of the following schemes has taken place?

A. A register disbursement scheme
B. A skimming scheme
C. A cash larceny scheme
D. None of the above

Answer 126

C. A cash larceny scheme

See pages 1.321, 1.401 in the Fraud Examiner’s Manual

The most straightforward cash larceny scheme is one in which the perpetrator opens the register and removes currency. This might be done while a sale is being conducted to make the theft appear to be part of the transaction or when no one is around to notice the perpetrator reaching into the cash drawer. For instance, a teller could log onto a register, perform a No-Sale transaction, and take currency from the drawer.

This scheme is not a register disbursement scheme because register disbursement schemes involve a fraudulent transaction that justifies the removal of cash from the register, such as a false return or a voided sale. Brittany did not make any entry that would account for the missing money. In addition, the scheme is not a skimming scheme because the money in the register was already a part of the company’s accounting system. There was no indication that the cash was part of an unrecorded or understated sale.

Question 127

Unauthorized personal use of a company vehicle constitutes misuse of a noncash asset, a form of asset misappropriation.

A. True
B. False

Answer 127

A. True

See pages 1.501 in the Fraud Examiner’s Manual

There are two ways a person can misappropriate a company asset: the asset can be misused (or “borrowed”) or stolen. Assets that are misused but not stolen typically include company vehicles, supplies, computers, and other office equipment.

Question 128

Which of the following scenarios is an example of a kickback scheme?

A. A vendor inflates the amount of an invoice submitted to the company for payment
B. An employee receives a payment for directing excess business to a vendor
C. A government official demands money in exchange for making a business decision
D. A politician threatens to close a business if it does not pay a bribe

Answer 128

B. An employee receives a payment for directing excess business to a vendor

See pages 1.602, 1.604, 1.608 in the Fraud Examiner’s Manual

Kickbacks are improper, undisclosed payments made to obtain favorable treatment. Thus, an employee receiving a payment for directing excess business to a vendor is an example of a kickback scheme. In such cases, there might not be any overbilling involved; the vendor simply pays the kickbacks to ensure a steady stream of business from the purchasing company.

Extortion is defined as the obtaining of property from another, with the other party’s consent induced by wrongful use of actual or threatened force or fear. Economic extortion is present when an employee or official, through the wrongful use of actual or threatened force or fear, demands money or some other consideration to make a particular business decision. Thus, an example of an economic extortion scheme is if a government official demands money in exchange for making a business decision. Similarly, another example of an economic extortion scheme would be if a politician threatens to close a business if it does not pay a bribe.

Question 129

Which of the following describes the primary purpose of an automated clearing house (ACH) filter?

A. It requires the bank to contact the account holder before any payments are made.
B. It matches the details of incoming payments with those on a list of expected payments provided by the account holder.
C. It is a tool used by auditors to examine electronic payment activity on the bank records.
D. It enables account holders to provide their banks with a list of criteria to ensure that only designated individuals are paid.

Answer 129

D. It enables account holders to provide their banks with a list of criteria to ensure that only designated individuals are paid.

See pages 1.435 in the Fraud Examiner’s Manual

Most large banks offer multiple security services that can help business account holders mitigate fraud through early detection and prevention of fraudulent electronic payments. For example, automated clearing house (ACH) blocks allow account holders to notify their banks that ACH debits should not be allowed on specific accounts. ACH filters enable account holders to provide their banks with a list of defined criteria (such as the sending company ID, account number, and transaction code) against which banks can filter ACH debits and reject any unauthorized transactions. Positive pay for ACH is another security feature offered by banks to their account holders. With positive pay, banks match the details of ACH payments with those on a list of legitimate and expected payments provided by the account holder. Only authorized electronic transactions are allowed to be withdrawn from the account; exceptions are reported to the customer for review.

Question 130

Which of the following is NOT an example of a corruption scheme?

A. A vendor gives expensive airplane tickets to a government purchasing agent as a thank-you gift after the agent awards a large contract to the vendor.
B. A bank manager promises to approve a contractor’s loan application in exchange for discounted home improvement work.
C. A procurement manager refuses to award contracts to vendors unless they agree to do business with the company where the manager’s spouse works.
D. A law firm’s bookkeeper approves a fake invoice and issues a payment to a shell company that the bookkeeper controls.

Answer 130

D. A law firm’s bookkeeper approves a fake invoice and issues a payment to a shell company that the bookkeeper controls.

See pages 1.601, 1.607-1.608, 1.610 in the Fraud Examiner’s Manual

The three major types of occupational fraud are corruption, asset misappropriation, and financial statement fraud. The bookkeeper’s payment to the shell company is an example of an asset misappropriation scheme, not a corruption scheme.

Corruption involves the wrongful use of influence to procure a benefit for the actor or another person, contrary to the duty or the rights of others. Corruption schemes include bribery, kickbacks, illegal gratuities, economic extortion, and collusion.

The bank manager’s promise to approve the contractor’s loan application in exchange for discounted home improvement work is an example of a bribe. Bribery is defined as the offering, giving, receiving, or soliciting of corrupt payments (i.e., items of value paid to procure a benefit contrary to the rights of others) to influence an official act or business decision. Bribes do not necessarily involve direct payments of cash or goods. Promises of favorable treatment can constitute corrupt payments.

The vendor’s gift of expensive airplane tickets is an example of an illegal gratuity. Illegal gratuities are items of value given to reward a decision, often after the recipient has made the decision. Illegal gratuities are similar to bribery schemes except that, unlike bribery schemes, illegal gratuity schemes do not necessarily involve an intent to influence a particular decision before the fact.

The procurement manager’s refusal to award contracts to vendors unless they agree to do business with the company where the manager’s spouse works is an example of economic extortion. Economic extortion is present when an employee or official, through the wrongful use of actual or threatened force or fear, demands money or some other consideration to make a particular business decision.

Question 131

All the following measures are recommended to help mitigate the risk of billing schemes EXCEPT:

A. Implementing a hotline function
B. Prohibiting competitive bidding
C. Providing objective compensation for purchasing staff
D. Separating the purchasing function from the payment function

Answer 131

B. Prohibiting competitive bidding

See pages 1.453-1.454 in the Fraud Examiner’s Manual

The prevention of purchasing fraud can be especially difficult. Education and training for the personnel in purchasing and accounts payable is one of the most effective fraud prevention measures. The second most effective purchasing fraud prevention measure is an objective compensation arrangement with people responsible for purchasing decisions.

For the best results and accountability, each company sufficient in size should have a separate purchasing department. Regardless of the company size, the purchasing function should be separate from the payment function. Furthermore, companies should implement a hotline function to provide a forum for complaints and fraud tips by employees and outsiders.

Whenever possible, companies should enforce competitive bidding. Competitive bidding is a transparent procurement method in which bids from competing contractors, suppliers, or vendors are invited by openly publicizing the scope, specifications, and terms and conditions of the proposed contract, as well as the criteria by which the bids will be evaluated. Competitive bidding aims at obtaining goods and services at the lowest prices by stimulating competition and preventing partiality and fraud.

Question 132

In a financial statement fraud scheme in which capital expenditures are recorded as expenses rather than assets, the transactions will have the following effect on the organization’s financial statements:

A. Net income will be overstated
B. Total assets will be understated
C. Sales revenue will be overstated
D. All of the above

Answer 132

B. Total assets will be understated

See pages 1.227, 1.231 in the Fraud Examiner’s Manual

Typically, a fraudster’s goal when committing a financial statement fraud scheme is to make the entity look stronger and more profitable. This goal is often achieved by concealing liabilities and/or expenses. To do this, the fraudster might fraudulently understate liabilities or improperly capitalize a cost that should be expensed.

Just as capitalizing expenditures that should be expensed is improper, so is expensing costs that should be capitalized. Improperly expensing costs will result in a lower net income, as well as understated assets. There are several reasons an entity might want to make itself look worse than it is. For example, the organization might want to minimize its net income due to tax considerations. Expensing an item that should be depreciated over a period of time would help accomplish that—net income would be lower and so would taxes. The result for the current accounting period is that total assets will be understated and expenses will be overstated.

Question 133

Which of the following schemes refers to the falsification of personnel or payroll records, causing paychecks to be generated to someone who does not work for the victim company?

A. Inflated commission scheme
B. Falsified salary scheme
C. Ghost employee scheme
D. Record alteration scheme

Answer 133

C. Ghost employee scheme

See pages 1.456 in the Fraud Examiner’s Manual

The term ghost employee refers to someone on the payroll who does not work for the victim company. Through the falsification of personnel or payroll records, a fraudster causes paychecks to be generated to a nonemployee, or ghost. The fraudster or an accomplice then converts these paychecks. The ghost employee might be a fictitious person or a real individual who does not work for the victim employer.

Question 134

What happens when an employee records a fictitious refund of goods at the employee’s cash register?

A. The register total is out of balance with the register log
B. The victim company’s inventory is overstated
C. Inventory is returned to the store
D. None of the above

Answer 134

B. The victim company’s inventory is overstated

See pages 1.403 in the Fraud Examiner’s Manual

A refund shows a disbursement of money from the register as the customer gets their money back. In a fictitious refund scheme, an employee processes a transaction as if a customer were returning merchandise, even though no actual return takes place. There are two results of this fraudulent transaction. First, the employee takes cash from the register in the amount of the false return. Since the register log shows that a merchandise return has been made, it appears that the disbursement is legitimate. The second repercussion is that a debit is made to the inventory system showing that the merchandise has been returned. Since the transaction is fictitious, no merchandise is returned. The result is that the company’s inventory is overstated.

Question 135

Corruption involves the wrongful use of influence to procure a benefit for the actor or another person, contrary to the duty or the rights of others.

A. True
B. False

Answer 135

A. True

See pages 1.601 in the Fraud Examiner’s Manual

The three major types of occupational fraud are corruption, asset misappropriation, and financial statement fraud. Corruption involves the wrongful use of influence to procure a benefit for the actor or another person, contrary to the duty or the rights of others. Corruption schemes include bribery, kickbacks, illegal gratuities, economic extortion, and collusion.

Question 136

The MOST EFFECTIVE way to prevent and detect electronic payment fraud is through proper separation of duties.

A. True
B. False

Answer 136

A. True

See pages 1.434 in the Fraud Examiner’s Manual

The most important practice for preventing and detecting electronic payment fraud is separation of duties. For example, in the case of online bill payments, such as those made through a bank’s website or a third-party business-to-business payment service, separate individuals should be responsible for maintaining payment templates, entering payments, and approving payments. For wire transfers, duties for creating, approving, and releasing wires should be segregated. And to prevent attempts to conceal fraudulent electronic payment activity, no individual involved in the payment process should reconcile the bank statement or even have access to it.

In addition to separating duties, companies should consider segregating their bank accounts to maintain better control over them—for example, separate accounts can be used for paper and electronic transactions.

Question 137

Grey, a controller for a small company, took a large sum of money from the company deposits and concealed the theft by making false accounting entries. The money that Grey stole had already been recorded in his company’s accounting system. Grey’s scheme can BEST be classified as a(n):

A. Cash larceny scheme
B. Skimming scheme
C. Illegal gratuities scheme
D. Fraudulent financial statement scheme

Answer 137

A. Cash larceny scheme

See pages 1.301 in the Fraud Examiner’s Manual

Skimming is defined as the theft of off-book funds. Cash larceny schemes, however, involve the theft of money that has already appeared on a victim company’s books. Neither of the other choices is correct because neither of those schemes is a type of asset misappropriation scheme. Grey’s scheme involves the misappropriation of company assets (cash).

Question 138

ABC Corporation is the defendant in a class-action lawsuit for selling defective consumer products. While the lawsuit is estimated to continue for several more years, ABC’s management believes that it is probable that the company will lose the lawsuit and be ordered to pay a significant amount of damages to the plaintiffs. ABC does NOT have to disclose a liability related to the lawsuit in its financial statements.

A. True
B. False

Answer 138

B. False

See pages 1.233 in the Fraud Examiner’s Manual

Typical liability omissions include the failure to disclose loan covenants or contingent liabilities. Loan covenants are agreements, in addition to or as part of a financing arrangement, that a borrower has promised to keep if the financing is in place. The agreements can contain various types of covenants, including certain financial ratio limits and restrictions on other major financing arrangements.

Contingent liabilities are potential obligations that will materialize only if certain events occur in the future. A corporate guarantee of personal loans received by a company officer and potential losses from ongoing litigation are examples of contingent liabilities that must be disclosed. Current accounting standards require entities to disclose contingent liabilities in the notes to the financial statements if it is reasonably possible that an outflow of cash will be required to settle a present obligation in the future.

Question 139

Which of the following is a common method that fraudsters use to conceal liabilities and expenses to make a company appear more profitable than it is?

A. Failing to disclose warranty costs and product-return liabilities
B. Omitting liabilities or expenses
C. Improperly capitalizing costs rather than expensing them
D. All of the above

Answer 139

D. All of the above

See pages 1.227 in the Fraud Examiner’s Manual

Understating liabilities and expenses is one of the ways financial statements can be manipulated to make a company appear more profitable than it is. Because pre-tax income will increase by the full amount of the expense or liability not recorded, this financial statement fraud method can significantly affect reported earnings with relatively little effort by the fraudster. There are three common methods for concealing liabilities and expenses:

• Omitting liabilities and/or expenses
• Improperly capitalizing costs rather than expensing them
• Failing to disclose warranty costs and product-return liabilities