Financial Statement Fraud: Free CFE Practice Questions

Question 1

In improper asset valuation schemes tied to business combinations, which of the following is a common manipulation of acquisition accounting that inflates future reported earnings?

Assigning excess purchase price to goodwill tested yearly for impairment Assigning excess purchase price to in-process R&D written off at acquisition Recording acquired fixed assets at their fair values as of the acquisition date Carrying acquired receivables at face value less an allowance for bad debt

Correct Answer: Assigning excess purchase price to in-process R&D written off at acquisition

Allocating excess purchase price to in-process research and development lets the acquirer expense that amount immediately at acquisition. The one-time charge is absorbed up front, so the asset never has to be amortized or impaired against later income, and future reported earnings look stronger.
Assigning the excess to goodwill tested yearly for impairment exposes future earnings to possible write-downs rather than inflating them. Recording acquired fixed assets at acquisition-date fair values is proper purchase accounting. Carrying receivables at face value less an allowance for bad debt is standard practice, not manipulation.
Key concept: purchase price allocation abuse and in-process R&D write-offs in business combinations.

Question 2

A fraud examiner reviewing a company's annual financial statements confirms that every vendor invoice, accrued expense and loan balance was recorded at the correct amount and in the proper period. However, the notes omit two items known to management: the company's guarantee of a bank loan taken by an entity owned by the chief executive, and a pending lawsuit that counsel considers likely to result in a material loss. Which financial statement fraud scheme BEST describes this conduct?

Timing-difference scheme Concealed liabilities Improper disclosures Improper asset valuation

Correct Answer: Improper disclosures

Because every recorded amount was correct and only the notes left out the related-party loan guarantee and the probable material lawsuit loss, this is an improper disclosures scheme. Management failed to disclose contingent liabilities and significant related-party transactions that users need to evaluate the statements.
Concealed liabilities involves omitting or understating recorded liabilities and expenses, but all recorded balances here were accurate. Improper asset valuation misstates asset carrying values, such as inventory or receivables. Timing-difference schemes record revenue or expenses in the wrong period, yet everything was in the proper period.
Key concept: failing to disclose contingent liabilities and related-party transactions in the notes is improper disclosure, even when the recorded numbers are correct.

Question 3

Why can an income statement line item show a large percentage increase in horizontal analysis while its percentage in vertical analysis stays nearly unchanged?

The prior-year base was itself distorted by a fraud from an earlier period Common-size figures use a moving average that smooths year-to-year changes Vertical analysis compares each item to industry averages for that period The base total, such as net sales, grew at roughly the same rate as the item

Correct Answer: The base total, such as net sales, grew at roughly the same rate as the item

Vertical analysis expresses each line item as a percentage of a base such as net sales, while horizontal analysis measures the change in the item's dollar amount across periods. If the base grows at roughly the same rate as the item, the item's dollar amount can rise sharply while its share of sales barely moves.
A prior-year base distorted by an earlier fraud would not by itself keep the vertical percentage stable. Common-size statements use the current period's actual totals, not moving averages. Vertical analysis compares items within a single statement, not against industry averages.
Key concept: horizontal analysis tracks period-to-period dollar changes, while vertical analysis tracks proportions relative to a base total.

Financial Statement Fraud

CFE - Financial Statement Fraud Example Questions

Question 1

Question 2

Question 3

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