Question

REVIEW QUESTIONS Chapter 7

1. Why might senior management overstate or understate business performance?

2. What are some of the ways in which financial statement fraud is committed?

4. What are the five classifications of financial statement fraud?

Answer 1

1)Senior management might overstate or understate business performance because they believe that the current year’s earnings are too low compared to the market expectations, so management tries to overstate business performance so that the company’s earnings can match or exceed market expectations resulting in an increase of the price per share of the company’s common stock. Moreover, senior management might overstate business performance in order to meet the requirements set by loan covenants, so that the company does not have to pay a penalty to the bank from which it borrowed funds.

2)Some of the ways in which financial statement frauds are committed a)Overstatement of Assets to reflect a stronger company b)Overstatement of Revenue to show fictitious growth in the company c)Understatement of Expenses to inflate the profit of the company d)Understatement of Liabilities to show a better picture of the company

4)The five classifications of financial statement schemes are fictitious revenues, timing differences, improper asset valuations, concealed liabilities and expenses, and improper disclosures.