CFA Financial Audit & Forensic Trails 3 — Questions and Answers
Question 1: Which concept describes the practice of recording revenue before it is earned to inflate financial results?
- Channel stuffing
- Premature revenue recognition (Correct answer)
- Cookie jar reserves
- Round-tripping
Correct answer: Premature revenue recognition
Premature revenue recognition records sales before the earnings process is complete, violating matching principles and inflating reported income.
Question 2: A forensic accountant discovers that a company's allowance for doubtful accounts has decreased significantly while accounts receivable days outstanding increased. This pattern most likely suggests:
- Improved collection efficiency
- Understating bad debt expense to inflate net income (Correct answer)
- A change in credit policy
- Increased sales to creditworthy customers
Correct answer: Understating bad debt expense to inflate net income
Declining reserves despite worsening receivable aging is a classic sign of manipulating bad debt expense to artificially boost earnings.
Question 3: The term 'lapping' in fraud refers to:
- Recording duplicate payments to the same vendor
- Concealing cash theft by applying later receipts to earlier accounts (Correct answer)
- Overstating inventory quantities during physical counts
- Routing payments through multiple bank accounts to obscure origin
Correct answer: Concealing cash theft by applying later receipts to earlier accounts
Lapping is a cash embezzlement scheme where funds stolen from one customer's account are covered by subsequent payments from other customers.
Question 4: Which forensic technique involves analyzing patterns in electronic metadata such as file creation times, modification dates, and author names?
- Net worth analysis
- Digital forensics and metadata examination (Correct answer)
- Physical inventory observation
- Ratio analysis
Correct answer: Digital forensics and metadata examination
Examining document metadata can reveal whether records were backdated, altered after creation, or created by someone other than the claimed author.
Question 5: Under the AICPA's SAS No. 99, auditors are required to:
- Report all fraud directly to the SEC
- Consider fraud risks and design audit procedures to address them (Correct answer)
- Obtain fidelity bond insurance for all employees
- Conduct surprise cash counts monthly
Correct answer: Consider fraud risks and design audit procedures to address them
SAS No. 99 requires auditors to identify and assess fraud risks and tailor audit procedures accordingly, including brainstorming sessions among audit team members.
Question 6: A 'shell company' is most commonly used in fraud schemes to:
- Legitimately reduce corporate tax obligations
- Create fictitious vendors or hide asset transfers and money flows (Correct answer)
- Consolidate subsidiaries for financial reporting
- Protect intellectual property across jurisdictions
Correct answer: Create fictitious vendors or hide asset transfers and money flows
Shell companies with no real operations are frequently used to create fake vendors, launder proceeds, or conceal related-party transactions.
Question 7: Which ratio would a forensic accountant most likely use to detect potential inventory fraud?
- Debt-to-equity ratio
- Inventory turnover ratio compared to industry benchmarks (Correct answer)
- Price-to-earnings ratio
- Current ratio trend over five years
Correct answer: Inventory turnover ratio compared to industry benchmarks
An abnormally low inventory turnover compared to industry peers may indicate overstated inventory balances used to inflate assets and reduce cost of goods sold.
CFA Financial Audit & Forensic Trails 3
Which concept describes the practice of recording revenue before it is earned to inflate financial results?