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.