What Is Your Fraud IQ?

BY JOSEPH T. WELLS
December 1, 2007

  

Fraud detection class is now in session. It’s time to put your smarts to the test and see how you score on these questions from the Association of Certified Fraud Examiners.

1. According to ACFE’s 2006 Report to the Nation on Occupational Fraud and Abuse , the typical organization loses what percentage of its annual revenue to fraud?
a. 1%
b. 5%
c. 10%
d. 20%

2. The most common method of concealing inventory theft is:
a. Misstating inventory counts
b. Padding the physical inventory
c. Falsifying journal entries
d. Altering shipping and receiving documentation

3. To prevent the forged endorsement of a check, which of the following is MOST critical?
a. The check preparer should not be able to modify the vendor addresses
b. Signed checks should not be returned to the preparer
c. The duties of receiving and delivering signed checks should rotate

4. The most basic and important control for detecting cash larceny from a deposit is to:
a. Monitor the deposit slip receipt for alterations
b. Compare monthly bank statements to the organization’s end-of-the-month report
c. Reconcile the receipt copy of the daily deposit slip with the organization’s daily receipts
d. None of the above

5. All of the following are methods of preventing overstated expense reimbursements EXCEPT:
a. Reviewing expense reimbursements per employee looking for individuals whose travel and entertainment expenses appear to be out of line
b. Spot-checking expense reports with vendors
c. Prohibiting the reimbursement of any expenses supported by a photocopied receipt without first verifying that the expense is legitimate
d. Reimbursing air travel expenses based only on itineraries supplied by travel agencies

6. Which of the following schemes might be used to increase a company’s income in the current year?
a. Understating liabilities
b. Capitalizing expenses
c. Improperly recording returns and allowances
d. All of the above

7. Which of the following scenarios would represent a departure from the prescribed method of obtaining a confirmation during a financial statement audit?
a. The auditor prepares the confirmation letter and allows the client to inspect the letter before the client mails it
b. The client mails the confirmation letter and a return envelope addressed to the auditor
c. Both a and b
d. Neither represents a departure from the prescribed procedure

8. A fictitious accounts receivable scheme almost always involves which of the following?
a. Fictitious inventory
b. Fictitious sales
c. Fictitious credit memos
d. Both b and c

9. Company XYZ has a controlling relationship over Firm C. This relationship must be disclosed in the notes to non-consolidated financial statements even if no transactions have occurred between the two companies.
a. True
b. False

10. A key indicator of fictitious revenues can be found through a comparison of the increase in sales to the change in which of the following accounts?
a. Cost of goods sold
b. Advertising expense
c. Shipping expense
d. Both a and c

ANSWERS
1. ( b ) According to the 2006 report, organizations typically lose approximately 5% of annual revenue to occupational fraud and abuse.

2. ( a ) There are several ways to conceal the theft of inventory. However, the most common approach is to misstate inventory counts. Often the fraudster simply overstates the amount of inventory recorded as counted to cover the amount stolen.

3. ( b ) Not returning signed checks to the preparer is fundamental. This segregation of duty breaks the disbursement chain so that no single person controls the entire payment process.

4. ( c ) One of the most basic and important controls for detecting cash larceny from a deposit is to reconcile the receipt copy of the daily deposit slip with the organization’s daily receipts. This is the best way to confirm that the bank actually received all of the money that the organization placed in the deposit.

5. (d) Overpurchasing schemes are particularly common with airline tickets. Do not reimburse air travel expenses based only on itineraries supplied by travel agencies. Require original documents to support the expense, and, if necessary, contact the airline in question to verify that the expense is legitimate.

6. ( d ) To increase income in the current year, a company might understate liabilities, creating a positive effect on the balance sheet in that equity or asset accounts would have to increase by the amount understated to keep the books in balance. Capitalizing expenses as assets and failing to expense costs during the correct period are also ways to increase income. Omitting or substantially understating the liability related to returns or allowances also can overstate income.

7. ( c ) The confirmation letter should be prepared by the client and given to the auditor for inspection and mailing. The auditor should include with the confirmation letter a return envelope with the auditor’s return address.

8. (d) The typical entry for fictitious accounts receivable is to debit accounts receivable and credit sales. Fictitious accounts receivable schemes are prevalent in companies experiencing financial difficulties and for companies in which managers receive a commission based on sales. In those cases, management tends to create fictitious accounts receivable toward the end of the year to overstate sales. In the following year, management might reverse the phony sales using fictitious credit memos.

9. ( b ) All material transactions between related parties must be disclosed in the financial statements. However, the mere existence of related parties, without any transactions conducted between the parties, does not need to be disclosed.

10. ( d ) Changes in cost of goods sold and shipping expenses should accompany changes in sales.

Joseph T. Wells , CPA, CFE, is founder and ­chairman of the Association of Certified Fraud Examiners and a contributing editor to the JofA . His e-mail address is jwells@acfe.com .

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