SI –Acct 284
Chapter 5
1. Who are the 4 main user groups of financial statements?
Internal users: managers and Board of Directors
External users: creditors, investors, and the government
2. What 3 things must exist for accounting fraud to occur?
Incentive
Opportunity
Character
3. What is the Sarbanes Oxley Act?
An act passed in 2002 by the US government which introduces stiffer
penalties for fraud and increases internal control requirements
4. ___SOX Act_______ is the most significant change to the financial reporting
environment in the United States.
5. What are 3 major business opportunity incentives for committing accounting fraud?
Satisfy loan covenants
Increase equity financing
Attract business partners
6. What are 3 major personal greed incentives for committing accounting fraud?
Enhance job security
Increase personal wealth
Obtain a bigger paycheck
7. In what two ways did SOX Act of 2002 reduce incentive to commit fraud?
Face fines for up to $5 Million
Face jail time for up to 20 years
8. What are three ways that SOX reduces opportunities to commit fraud?
 Mangers must review how well their company’s internal controls worked
during the year and issue a report that indicates whether the controls
over financial reporting operated effectively.
 Board of directors is required to establish an audit committee made up
of independent directors to oversee financial matters of the company.
 Company’s external auditors are now required to test the effectiveness
of the company’s internal controls and issue a report that indicates
whether they agree with the conclusions of the internal control report
issued by management.
9. What are three ways that SOX encourages good character?
 SOX grants legal protection to whistle-blowers.
 Audit committee must create a tip line to allow employees to secretly
submit concerns.
 Companies must adopt a code of ethics
10. Match each of the following SOX requirements to the corresponding element of the fraud
triangle by entering the appropriate letter in the space provided
___C___ Establish a tip line for employees to report questionable acts
___A___ Increase maximum fines to $5 million.
___B___ Require management to report on effectiveness of internal controls
___A___ Legislate whistle-blower protections
___B___ Require external auditors report on internal control effectiveness
A. Incentive
B. Opportunity
C. Character
11. __Comparative financial statements_____ includes numbers for two or more time
periods to make it easy for users to compare account balances from one period to the
next.
12. What is the difference between a single-step income statement and a multistep income
statement?
A single step reports net income by subtracting a single group of expenses
from a single group of revenues.
A multistep reports income by dividing expenses into different subtotals,
such as operating, general, administrative expenses.
13. What is the purpose of the multistep income statement?
External users are able to see how expense are divided into the different
subtotals.
14. What is the largest expense on the income statement?
Cost of Goods Sold
15. What is the equation used to calculate gross profit?
Net Sales
-COGS
Gross Profit
16. Fill in the missing account titles of the multistep income statement
Net sales
- _COGS_____
=
=
_Gross Profit_____
Operating expenses
Income from operations___
+/- Other Revenue and Expenses
=
=
_Income before Income tax expense_______
__tax expense______
Net Income
17. What are you taxed on pretax income or net income?
Pretax income
18. Using the following account balances prepare a multistep income statement on the back
of this sheet.
Sales Revenue
$100,000
Other Revenue
$50,000
Rent Expense
$12,000
COGS
$60,000
Wage Expense
$15,000
Depreciation Expense
$10,000
Other Operating Exp
$12,000
Interest Revenue
$1000
Interest Expense
$500
Income Tax Rate
30%
Sales Revenue
COGS
Gross Profit
Wage Expense
Rent Expense
Depreciation Exp.
Income from Op.
Other Revenue
Interest Rev.
Other Oper. Exp.
Interest Exp.
Income Before Tax
Tax Expense
Net Income
100,000
(60,000)
40,000
(15,000)
(12,000)
(10,000)
3000
50,000
1000
(12,000)
(500)
41,500
(12,450)
29,050
{41,500 * 0.3}
19. __C_ 1. Users of financial statements
_E__ 2. Objective of financial statements
_I__3. Consistency
_G__4. Comparability
_F__5. Separate Entity
_A__6. Unit of Measure
_B__7. Cost principle
_D__8. Revenue principle
_J__9. Matching Principle
_K__10. Conservatism
__H___ 11. Full Disclosure
A. Counted unused supplies at the end of the period and valued them in US dollars
B. Valued an asset at the amount paid to acquire it, even through its market value has
increase considerably
C. Analyzed the financial statements to assess the company’s performance
D. Established an accounting policy that sales revenue shall be recognized only when
services have been provided to the customer
E. Prepared and distributed financial statements that provide useful economic
information
F. Established a policy not to include in the financial statements the personal financial
affairs of the owners of the business
G. Changed the company’s year-end to correspond to that used by others in the
industry
H. Disclosed all relevant financial information about the business in the financial
statements
I. Established a policy to report the company’s recurring business activities in the same
way from year to year
J. Adjusted the rent accounts to show the cost of rent relating to the current period
K. Acquired a vehicle for use in the business, reporting it at the agree-upon purchase
price rather than its higher sticker price.