ANSWER KEY CHAPTER 1 END OF CHAPTER MATERIAL

Solutions Manual fo Forensic Accounting and Fraud Examination, 2e Richard Riley, Mary- Jo Kranacher (All Chapters) 1 / 4

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End of Chapter Material

Chapter 1

ANSWER KEY – CHAPTER 1 END OF CHAPTER MATERIAL

CRITICAL THINKING

CT-1 Anthony and Cleopatra. Everything needed to answer the question “how did they die?” is

contained in the following passage:

Anthony and Cleopatra are lying dead on the floor in a villa. Nearby on the floor is a broken bowl. There is no mark on either of their bodies, and they were not poisoned. With this information, determine how they died.

Solution. Suffocation. Why? Anthony and Cleopatra are fish. This fact would be observed as soon as the investigator enters the room. Fish out of water, “lying dead on the floor” would lead to suffocation as the most likely cause of death. The issue is one of assumptions. Most readers assume that Anthony and Cleopatra are people. This tends to limit the ability of the reader to “think outside the box” to derive the proper solution. The challenge is that most people make assumptions and do not even realize that an assumption is being made. For forensic accounting and fraud examination professionals, it’s critical to keep an open mind, overtly (to the extent possible) identify all assumptions and base conclusions solely on the evidence available.

CT-2 The Light Switch. A man stands at one end of a 100 meter curved hallway where he cannot see the end. Next to him are three light switches, and at the end of the hall is one incandescent light.How many feet will the man have to walk to definitively say which light switch operates the light?

Solution. 100 meters. How do we know for sure?Flip on switch 1 and leave it one for a minute or two, then switch it off Flip on switch 2 and immediately walk 100 meters to the end of the hallway

If:

• The Light is On, Then Switch 2 Controls the Light; • The Light is Off but Warm, Then Switch 1 Controls the Light; • The Light is Off and Cold, Then Switch 3 Controls the Light

REVIEW QUESTIONS

1-1 Define fraud and identify a potentially fraudulent situation.

Answer: Fraud is an intentional deception, whether by omission or co-mission, that causes its victim to suffer an economic loss and/or the perpetrator to realize a gain.

Potentially fraudulent situations may include, for example:

• Misappropriation of funds, securities, supplies, or other assets.• Impropriety in the handling or reporting of money or financial transactions.• Profiteering as a result of insider knowledge of company activities.• Disclosing confidential and proprietary information to outside parties.• Disclosing to others, securities activities engaged in or contemplated by the company. 2 / 4

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• Accepting or seeking anything of material value from contractors, vendors, or persons providing services/materials to the Company. Exception: Gifts less than US $50 in value.• Destruction, removal, or inappropriate use of records, furniture, fixtures, and equipment.

1-2 Differentiate between fraud and abuse.

Answer: Although both fraud and abuse involve an intentional deception that causes its victim to suffer an economic loss and/or the perpetrator to realize a gain, abuse does not rise to the level of fraud. Abuse is often a way to describe a variety of petty crimes and other counterproductive behavior, such as surfing the web while at work, coming to work late or leaving early, using sick leave when not sick, that have become common and even silently condoned in the workplace.

1-3 Describe the services that a forensic accountant might provide related to a marital dispute.

Answer: Forensic accountants may assist attorneys with assembling the financial

information necessary to either bolster (if hired by the plaintiff) or undercut (if hired by the defendant) a case. This may include, for example, locating hidden marital assets or income, calculating the present value of future cash flow from retirement plans and providing testimony in the case.

1-4 Explain the differences between an audit, fraud examination, and forensic accounting engagement.

Answer: Audits, fraud examinations, and forensic accounting engagements have six major

differences:

• Timing - Audits are conducted on a regular recurring basis while a fraud examination is

nonrecurring and is only conducted on sufficient predication. A forensic accounting engagement is also nonrecurring and is only conducted after an allegation of misconduct.

• Scope - The scope of an audit is general while the scope of a fraud examination or

forensic accounting engagement is specific. Audits are a general examination of financial information for material misstatements while fraud examiners and forensic accountants are engaged to resolve a specific allegation.

• Objective - The objective of auditing is to express an opinion on the financial statements

of an organization. The objective of a fraud examination is to determine whether or not fraud has taken place and to determine who is responsible, while a forensic accounting engagement is to determine the financial impact of the allegations.

• Nature of the relationship - Auditing is non-adversarial while fraud examination is

adversarial in nature. The forensic accountant is independent.

• Methodology - Auditing primarily entails examining financial data, while fraud

examination and forensic accounting involve gathering sufficient financial and non- financial evidence to meet their objective.

• Approach - Auditors are required to approach an audit with professional

skepticism while fraud examiners and forensic accountants attempt to establish sufficient proof to meet their objective. 3 / 4

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1-5 Explain the theory of the fraud triangle.

Answer: The fraud triangle provides an explanation for the conditions necessary for fraud to occur – perceived pressure, perceived opportunity, and rationalization.

1-6 List the legal elements of fraud.

Answer: Under common law, fraud includes four essential elements:

• A material false statement
• Knowledge that the statement was false when it was spoken
• Reliance on the false statement by the victim
• Damages resulting from the victim’s reliance on the false statement

1-7 Identify common fraud schemes.

Answer: Common fraud schemes include asset misappropriation, corruption, and false statements.

1-8 Give examples of non-fraud forensic and litigation advisory engagements.

Answer: Engagements may be criminal, civil or administrative cases that involve

economic damage claims, workplace or matrimonial disputes, or asset and business valuations.

1-9 Describe the fraud examiner/forensic accountant’s approach to investigations.

Answer: Fraud examination and forensic accounting entail examining documents,

reviewing records, and interviewing witnesses.

1-10 Explain fraud examination methodology.

Answer: Fraud examination involves obtaining documentary evidence, interviewing

witnesses and potential suspects, writing investigative reports, testifying to findings, and assisting in the general detection and prevention of fraud.

MULTIPLE CHOICE QUESTIONS

• Which of the following is not an essential element of fraud?
• A material false statement
• Knowledge that the statement was false when it was spoken
• Evidence that the statement was false
• Damages resulting from the victim’s reliance on the false statement

Answer: C. Evidence is not an essential element. Evidence supporting each element is assumed.

• Select from the following situations the one that should not be defined as abuse:
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