Financial Statement Fraud Flashcards

Which of the following is an example of an off-balance-sheet financing scheme?

Answer: Using special purpose entities (SPEs) to hide debt

Special purpose entities (SPEs) can be used to move liabilities off the company's balance sheet, making the company appear less leveraged than it actually is.

Which scheme involves capitalizing ordinary operating expenses to make a company appear more profitable?

Answer: Improper capitalization of expenses

Improper capitalization shifts operating expenses to the balance sheet as assets, reducing reported expenses and artificially inflating net income.

The Enron scandal is most closely associated with which financial statement fraud technique?

Answer: Concealing debt through special purpose entities

Enron used hundreds of special purpose entities to hide billions in debt from its balance sheet, artificially improving its reported financial position.

What analytical technique compares each line item on a financial statement as a percentage of a base amount to detect anomalies?

Answer: Vertical (common-size) analysis

Vertical (common-size) analysis expresses each line item as a percentage of a base (e.g., total revenue), making it easier to spot unusual proportions that may indicate manipulation.

In a 'bill-and-hold' fraud scheme, revenue is recognized when:

Answer: Goods are invoiced but not yet shipped to the customer

Bill-and-hold fraud records revenue when goods are invoiced but remain in the seller's possession, violating the delivery condition for revenue recognition.

Which Benford's Law application is most useful in detecting financial statement fraud?

Answer: Testing whether the first digits of large numbers conform to expected frequency distributions

Benford's Law predicts the frequency distribution of leading digits in naturally occurring data; deviations can indicate fabricated or manipulated numbers.

What does the 'Big Bath' earnings management technique involve?

Answer: Taking large write-offs in a bad year to clear the slate for future reported profits

A 'big bath' occurs when management takes excessive write-offs in an already bad period, depressing current-year earnings further to set a lower baseline for improved future results.