CFFE Module I
Introduction to Forensic Accounting and Audit flashcards
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What is the accounting equation, and how does a fictitious sale distort it?
Assets = Liabilities + Equity. A fictitious credit sale debits receivables (an asset) and credits revenue, which flows into equity through retained earnings, so assets and equity both rise with no genuine change behind them. No cash ever arrives, so the receivable eventually surfaces as an unexplained bad debt or a balance that never converts to cash.
What are the five components of internal control?
Control environment: the tone and culture leadership sets toward integrity and control. Risk assessment: identifying and evaluating risks to reliable reporting. Control activities: specific policies and procedures, such as authorisation, segregation of duties and reconciliation. Information and communication: getting relevant information to the people who need it for their control responsibilities. Monitoring: ongoing evaluation of whether controls actually work as designed.
What are the five financial statement fraud schemes?
Revenue recognition fraud: revenue recorded prematurely, fictitiously or before it is earned. Overstatement of assets: inventory, receivables or fixed assets inflated beyond their real worth. Understatement of liabilities: genuine obligations concealed or omitted, off-balance-sheet arrangements in particular. Improper expense recognition: expenses deferred, capitalised or omitted. Improper disclosures: required note information omitted or misrepresented.
How does an overstated closing inventory figure inflate profit?
Cost of goods sold = opening inventory + purchases - closing inventory. Overstating closing inventory understates cost of goods sold, and so overstates gross profit, by exactly the amount of the overstatement. Example: opening KES 2,000,000, purchases KES 12,000,000, closing reported at KES 5,000,000 against a true KES 3,800,000. Reported cost of goods sold is KES 9,000,000, the true figure KES 10,200,000, so gross profit is overstated by KES 1,200,000.
Why is the statement of cash flows a particularly useful forensic tool?
Genuine cash movements are harder to fabricate convincingly than accrual-based figures: a fictitious sale or a deferred expense is easy on paper, matching cash moving through real bank accounts is not. So a profitable-looking entity with weak or negative operating cash flow is a classic red flag: the reported profit is not turning into cash.
What does Benford's Law predict, and how is it used in forensic accounting?
In many naturally occurring datasets the leading digit 1 appears far more often than higher digits. Expected frequency = log10(1 + 1/d): about 30.1% for 1, 17.6% for 2 and only 5.8% for 7. Fabricated numbers tend to be spread too evenly across digits, so a deviation flags transactions for closer examination. A deviation is a lead, never proof of fraud.
How does a forensic audit differ from a traditional (statutory) audit?
Statutory audit: reasonable assurance on the financial statements as a whole, sample-based, not designed specifically to detect fraud. Forensic audit: triggered by a specific suspicion, narrow and deep in scope, aimed at establishing facts usable as legal evidence.
How do forensic accounting, forensic audit, financial audit and fraud investigation relate to each other?
Forensic accounting: the broad discipline, applying accounting skill to legal matters generally. Forensic audit: one forensic-accounting engagement, examining records for evidentiary purposes. Financial (statutory) audit: reasonable assurance on the statements generally, not fraud-specific. Fraud investigation: the wider process of establishing what happened and who was responsible, of which a forensic audit is often one component.
Who is responsible for preventing and detecting fraud, management or the external auditor?
Management, through its own internal controls, with those charged with governance overseeing the reporting process. The external auditor opines on whether the statements are fairly presented, giving reasonable, not absolute, assurance, and is not primarily a fraud detector. Do not conflate the two roles.
What does The Ikarian Reefer [1993] 2 Lloyd's Rep 68 require of an expert witness such as a forensic accountant?
Expert evidence must be the independent product of the expert, uninfluenced by the exigencies of litigation. The expert assists the court and never becomes an advocate. Facts and assumptions are stated, including material that detracts from the opinion. An opinion that is provisional for lack of data must be stated as provisional.
What is accounting?
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Who are the internal and external users of accounting information?
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How does the accrual basis differ from the cash basis, and which is easier to manipulate through timing?
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What do the consistency and prudence concepts require, and why do they matter to a forensic examiner?
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What does the going concern concept assume?
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What are the stages of the accounting cycle?
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What is each party responsible for in relation to an entity's accounts?
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What does Caparo Industries plc v Dickman [1990] 2 AC 605 say about whom the statutory audit serves?
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What standard did Re Kingston Cotton Mill Co (No 2) [1896] 2 Ch 279 set for an auditor?
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Give an example of each type of regulatory body in accounting.
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Why are strong control activities not enough if the control environment is weak?
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Why can a public sector entity not simply adopt IFRS unmodified?
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What are the three layers of regulation of the accounting profession, and what does each do?
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What did Re Barings plc (No 5) [2000] 1 BCLC 523 decide about delegation by directors?
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What did Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 decide?
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How do financial statements differ between a sole proprietor, a company and an NGO?
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What is fund accountability in an NGO's accounts?
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What is revenue recognition fraud? Give an example.
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What is improper expense recognition? Give an example.
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Why is an off-balance-sheet liability harder to detect than an inflated asset?
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What does the balance sheet report, compared with the profit and loss account?
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What does the statement of owner's equity show, and why is it useful forensically?
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What are the four categories of financial ratio? Give an example of each.
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How are receivables days worked out, and what makes a change in them a red flag?
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Gross profit margin falls from 30.0% to 14.8% while revenue is almost flat. What could explain it?
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What is forensic accounting?
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How does forensic accounting differ from traditional accounting?
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Give five types of non-fraud forensic accounting work.
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In a Benford's Law test of expense claims, what might a spike in amounts leading with 7 mean?
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When is Benford's Law not an appropriate test?
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What does Derry v Peek (1889) 14 App Cas 337 require before an error can be called fraud?
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What key skills does a forensic accountant need?
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What qualities are expected of a forensic accountant, and how is scepticism different from distrust?
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Which ethical obligations bind a forensic accountant?
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What is a forensic audit?
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Which two questions decide whether a scenario describes a forensic audit, a statutory audit or a fraud investigation?
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Which skills do forensic auditors share with forensic accountants, and where is their particular emphasis?
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Why can a technically correct forensic finding still be legally worthless?
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What qualities are expected of a forensic auditor?
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