ACCOUNTING INFORMATION SYSTEMS SYSTEMS CONTROLS AND PROCESSES TURNER / WEICKGENANNT CHAPTER 5: Corporate Governance and the Sarbanes-Oxley Act TEST BANK - CHAPTER 5 - TRUE / FALSE 1. Research indicates that companies who stress corporate corporate governance tend tend to be rewarded with higher rates of return and a lower cost of capital. 2. The high cost related related to corporate governance governance far outweighs any of the related benefits. 3. The purpose of corporate corporate governance is to encourage encourage the efficient efficient use of resources resources and to require accountability of those resources. 4. The various groups whose whose interests are related to corporate corporate governance will generally generally have no conflicts with each other. 5. In order to be considered considered a stakeholder in corporate governance, governance, the participant must must be external. 6. The management management group tends to to have an indirect impact on corporate governance, while the the business community tends to have a direct affect. 7. Even though shareholders shareholders are identified identified as internal stakeholders, stakeholders, they are often regarded as external stakeholders because of the lack of involvement. 8. Top management management is made up of managers managers who coordinate coordinate a number of different different departments or groups within a company and lead the supervisors in their area of responsibility. 9. The management management team of a corporation corporation is often divided into three layers – top management, management, middle management, and supervisors. 10. The external auditors auditors should approach every audit with an optimistic attitude which will help them to gain more cooperation from the employees within the organization. 11. Even though the the people and organizations organizations within a community community are not directly related to a corporation, they would still be considered one of the stakeholders. 12. Internal auditors should should not allow any financial financial connections to to influence the decisions decisions they make about the company’s financial statements or disclosures. 13. Good management management oversight involves leaders who are good communicators communicators - responsive responsive to both those above and below in the chain of command. 14. The goal of corporate governance, governance, with respect respect to internal controls controls and compliance, is to ensure that financial information is i s accurate and transparent.
15. Maintaining effective internal controls and ensuring ensuring compliance is a six-step process which does not require continual monitoring. 16. Earnings management management tends to to have a snowball effect, effect, which means that that once it is started, started, it is necessary to continue the process in order to avoid a negative result. 17. Earnings management management is not unethical unethical because because it will result in a higher return for the shareholders. 18. Because of its widespread widespread relevance, ethical ethical conduct is often valued as the most important part of corporate governance. 19. Prior to the passage passage of the Sarbanes-Oxley Sarbanes-Oxley Act, an auditing auditing firm was prohibited from providing providing non-audit services to their clients. 20. Before the passage passage of the Sarbanes-Oxley Sarbanes-Oxley Act it was common common for auditors to to perform many non-audit services for their customers. 21. Non-audit services are are now prohibited because because of the potential potential to impair the auditor’s auditor’s objectivity. 22. Even though non-audit non-audit services are prohibited prohibited by Sarbanes-Oxley, Sarbanes-Oxley, the auditor may may perform income tax services for their audit clients if they are pre-approved by the CEO. 23. The auditors auditors report directly to the Board Board of Directors. Directors. 24. The Audit Committee Committee is responsible for hiring, hiring, firing, and overseeing overseeing the audit firm and serving as the liaison between the audit firm and management. 25. In order to remain independent, independent, members members of the audit committee must must receive compensation compensation from the company for their service to the company. 26. If an officer of a public company company fails to certify financial reports reports or certifies those those that are known to be misleading, the officer may be subject to stiff penalties of up to $1,000,000 and prison term up to 5 years. 27. The Sarbanes-Oxley Sarbanes-Oxley Act contains a section section referred to as the “whistle-blower “whistle-blower protection” section that is intended to protect a whistleblower from retaliation by the company or its employees. 28. The audit committee committee is the point of contact contact on financial matters matters and serves serves as the supervisor supervisor of the board of directors. 29. Corporate management management serves serves as supervisors supervisors to the the board of directors. directors. 30. Sarbanes-Oxley has resulted in increased increased levels of responsibility responsibility for business leaders at all levels.
31. Even if top managers managers are intent to to do wrong, it is likely that an organization could could develop a set of checks and balances that could completely prevent them from doing so. 32. Data mining software has become more important important to corporate corporate governance because because of its ability to help signal frauds. 33. When managers are faced with decision decision making in troubled times, it is necessary necessary for them to protect as many jobs as possible, regardless of the impact on individual shareholders. 34. It is not necessary necessary for the audit committee committee to maintain independence, as as long as they are performing their duties in the proper manner. 35. In today’s business business environment, there there is not a substitute substitute for the integrity integrity and ethics of a company’s leaders. ANSWERS TO TEST BANK – CHAPTER 5 – TRUE / FALSE: 1. 2. 3. 4. 5. 6. 7.
T F T F F F T
8. 9. 10. 11. 12. 13. 14.
F T F T F T T
15. 16. 17. 18. 19. 20. 21.
F T F T F T T
22. 23. 24. 25. 26. 27. 28.
F F T F F T T
29. 30. 31. 32. 33. 34. 35.
F T F T F F T
TEST BANK - CHAPTER 5 - MULTIPLE CHOICE 36. Which of the following groups groups would use factors such as those those that affect the the supply and demand of corporate leaders and tend to emphasize the importance of motivating leaders through the use of incentive programs as part of their definition of corporate governance? A. Financiers B. Economists C. Accountants D. Lawyers 37. This group of business would tend to emphasize emphasize the role of corporate leaders to to provide a good rate of return. A. Financiers B. Economists C. Accountants D. Lawyers
38. This group of business business would tend to emphasize emphasize the role role of corporate leaders as as providing effective internal controls and accurate records. A. Financiers B. Economists C. Accountants D. Lawyers 39. A system of checks and and balances where where a company’s leadership is held accountable accountable for building shareholder value and creating confidence in the financial reporting process is called: A. Internal Control B. Tone at the Top C. Code of Conduct D. Corporate Governance 40. Key A. B. C. D.
ingredients ingredients in the the concept of corporate governance include: Motivation of leaders Providing high rates of return and and low costs costs of capital capital Building value and creating confidence Efficient use of resources
41. The A. B. C. D.
set of values and behaviors in place place for the corporate corporate leaders is referred to to as: Corporate Governance Governance Tone at the Top Internal Control Stakeholders
42. There are are a number number of different participants participants in the corporate governance process. These participants are referred to as: A. Leaders B. Managers C. Shareholders D. Stakeholders 43. All of the different people who have some form of involvement or interest interest in the business business are referred to as: A. Employees B. Stakeholders C. Executives D. Shareholders 44. The group of people who who participate in or with with the business in a manner that that puts them in a position of financial interest or risk, or is i s otherwise significant to the overall strategies and operations of a business are called: A. Managers B. Board of Directors C. Stakeholders D. Audit Committee
45. The internal stakeholders would not include: A. Creditors B. Shareholders C. Internal Auditors D. Audit Committee 46. The A. B. C. D.
internal internal stakeholders who who own a portion of the corporation are called: Directors Shareholders Audit Board Executives
47. This group of stakeholders stakeholders should have the the highest level of authority authority related to the the company’s objectives and strategies. strategies. Elected by the shareholders, it’s role is to align the interests interests of the shareholders and management. management. A. Audit Committee B. Internal Auditors C. Board of Directors D. Executive Branch 48. This group of stakeholders stakeholders is responsible for financial financial matters, including including reporting, controls, and and the audit function. A. Audit Committee B. External Auditors C. Board of Directors D. Internal Auditors 49. Which of the following properly properly identifies the top management management level of the management management team? A. Guide the work of a number number of employees doing similar tasks within a department or group. B. Coordinate a number of different departments departments within the company by overseeing supervisors. C. Made up of the company’s company’s president and chief executive executive officer. D. Carry out the the day-to-day operations operations and administrative functions functions of the company. 50. This group of stakeholders stakeholders help management management establish and and monitor the internal internal controls for the company. They rotate throughout throughout the company, company, reviewing policies, procedures, procedures, and reports reports in each area to determine whether or not they are working as planned. A. External Auditors B. Internal Auditors C. Audit Committee D. Top Management
51. People and organizations organizations outside the corporation corporation who have a financial interest interest in the corporation are referred to as: A. External Auditors B. External Stakeholders C. Securities and Exchange Commission D. Treadway Commission 52. Which of the following groups is NOT considered to be an external stakeholder? stakeholder? A. Audit Committee B. External Auditors C. Governing Bodies D. Customers 53. The purpose of this group of stakeholders stakeholders is to add add credibility to to the financial statements. statements. They are responsible for evaluating whether or not the financial statements have been prepared according to the established accounting rules. A. Internal Auditors B. Governing Bodies C. Audit Committee D. External Auditors 54. The governing group is responsible for establishing establishing applicable financial financial accounting standards standards in the United States: A. COSO B. SEC C. FASB D. IASB 55. This governing group is responsible responsible for establishing establishing applicable financial financial accounting standards globally: A. COSO B. SEC C. FASB D. IASB 56. This governing group is the the federal regulatory regulatory agency responsible for protecting the interests interests of investors by making sure that public companies provide complete and transparent financial information: A. COSO B. SEC C. FASB D. IASB 57. This A. B. C. D.
governing group created the the framework framework for internal controls evaluations: evaluations: COSO SEC FASB IASB
58. It is necessary that that certain stakeholders stakeholders remain independent independent related related to the corporation’s financial reporting. Which of the following correctly correctly states the stakeholders that that should remain independent? A. Internal Auditors, Audit Audit Committee and and External Auditors B. Audit Committee and Internal Auditors C. External Auditors and Audit Committee D. Both Internal and External Auditors 59. The system of checks checks and balances balances in corporate governance governance includes several several interrelated functions. Which of the the following is not one of those functions? A. Management Oversight B. Financial Stewardship C. Ethical Conduct D. Governing Bodies 60. The concept that that encompasses the policies and procedures procedures in place to lead lead the directorship of the company is called: A. Financial Stewardship Stewardship B. Management Oversight C. Ethical Conduct D. Internal Controls and Compliance 61. Which of the following is not typical typical relationship in an organization organization chart? chart? A. Supervisors report to to managers B. Managers report to officers C. Managers report to supervisors D. Officers report report to the board of directors 62. According to the authors, authors, the downfall of Enron Enron involved poor management management oversight, and included the following criticism(s) of the board of directors: A. Board meetings were were few and brief B. They did not challenge the the company’s aggressive accounting accounting policies C. Board allowed senior senior executives to be exempted exempted from the the company’s policies regarding conflicts of interest D. All of the above 63. The A. B. C. D.
correctness correctness of the financial information presented presented is called: Accuracy Transparency Stewardship Fiduciary
64. This characteristic characteristic of financial information, relates relates to how clearly clearly the information can be understood. It requires a straightforward, straightforward, consistent, consistent, and timely approach. approach. A. Accuracy B. Financial Stewardship C. Fiduciary Duty D. Transparency
65. Companies that emphasize emphasize accuracy accuracy and transparency: A. Will have internal controls controls in place to make sure sure that their their financial reports do not not contradict each other. B. Will have fewer opportunities opportunities for errors or fraud. C. Will be more likely to prevent opportunities opportunities for wrongdoers to cross cross the line into fraud. D. All of the above. 66. A special obligation of trust, trust, especially with respect respect to the finances finances of another, is called: called: A. Financial Stewardship Stewardship B. Fiscal Transparency C. Fiduciary Duty D. Internal Controls 67. Within the corporate environment, environment, this term term means that that management management has been entrusted entrusted with the power to manage the assets of the corporation, which are owned by the shareholders. A. Fiscal Transparency B. Fiduciary C. Stewardship D. Accuracy 68. The A. B. C. D.
manner in which an agent handles the affairs affairs and/or finances of another is referred referred to as: Financial Stewardship Stewardship Fiscal Transparency Accuracy Fiduciary
69. The most important important factors for success success in a leader in fulfilling the duty of financial financial stewardship are: A. Financial Stewardship Stewardship and Fiscal Transparency Transparency B. Financial Accuracy and Internal Control C. Fiduciary Duty and Ethical Conduct D. Good Communication Communication and Open Dialogue 70. In order for an environment environment to thrive where where corporate leaders can be good financial stewards: stewards: A. Well-defined rules and procedures procedures must be in place for decision making. making. B. It is necessary necessary to consider objectives at the starting point. C. Any decision made made must be in the best interest of the shareholders. shareholders. D. All of the above. 71. The act of manipulating manipulating financial information information in such a way as to shed more more favorable light on the company or its management than is actually warranted is referred to as: A. Financial accountability B. Earnings management C. Income performance D. Financial stewardship
72. Which of the following is not one of the typical earnings management techniques? A. Early revenue recognition recognition B. Falsification of customers C. Creation of non-existent vendors D. Early shipment of products 73. According to the authors, authors, the origin of the corporate governance governance concept in the United United States coincides with: A. The passage of Sarbanes-Oxley Sarbanes-Oxley Act B. The creation creation of the Public Company Company Accounting Accounting Oversight Board C. The establishment establishment of the the SEC and and enactment enactment of the securities securities laws D. The Treadway Treadway Commission Commission and the ultimate ultimate creation of COSO 74. The Securities Act of 1933 requires: A. The implementation implementation of a proper climate of internal controls B. The full disclosure of financial information information through the filing of registration registration statements statements before the securities can be sold C. Ongoing disclosures disclosures for registered companies, in addition to the regulation stock exchanges, brokers, and dealers. D. The legislation enacted to combat deceptive accounting practices practices by banks and financial institutions 75. The Securities Securities Exchange Exchange Act of 1934 requires: A. The implementation implementation of a proper climate of internal controls B. The full disclosure of financial information information through the filing of registration registration statements statements before the securities can be sold C. Ongoing disclosures disclosures for registered companies, in addition to the regulation stock exchanges, brokers, and dealers. D. The legislation enacted to combat deceptive accounting practices practices by banks and financial institutions 76. The A. B. C. D.
establishment establishment of the SEC and the enactment enactment of securities laws were responses responses to: The stock market crash of 1929 and the Great Depression of the 1930s 1930s Market pressures during the 1980s Increased inflation inflation and cost of capital during the 1970s 1970s High-profile accounting accounting scandals scandals in the early early 2000s 2000s
77. This legislation was enacted in an effort effort to curb the corruption corruption and accounting accounting blunders that had been discovered in connection with the bankruptcies of corporate giants, such as WorldCom. A. Securities Exchange Exchange Act B. US Patriot Act C. Sarbanes-Oxley Act D. Securities Act
78. The A. B. C. D.
PCAOB PCAOB was established to carry the the provisions of the: Sarbanes-Oxley Act Securities Act US Patriot Act Securities Exchange Act
79. The Sarbanes-Oxley Act relates to: A. Private companies and and auditors of public companies companies B. Public companies C. Auditors of public companies companies and and public companies D. Auditors of private companies 80. Auditors of public companies are now prohibited from from providing non-audit services services to their audit clients as a result of which section of the Sarbanes-Oxley Act: A. Section 201 B. Section 301 C. Section 302 D. Section 401 81. Title II of the Sarbanes-Oxley Sarbanes-Oxley Act relates to auditor independence independence and includes includes items such as: as: A. Requiring the lead partner partner on a public company audit to rotate rotate off the engagement engagement each year. B. If an auditor is hired away from the audit firm to take a job with the client, there there must be a cooling off period of three years if the new job is in a key accounting role. C. If the auditor’s involvement involvement with the design design of the client’s client’s accounting information information system and expands into areas of IT system development, then the auditor is considered to have impaired independence. D. Auditors of public companies companies are now allowed to provide non-audit services to their their audit clients. 82. Which of the following is not considered considered to be a non-audit service? A. Preparation of accounting accounting records and financial financial statements statements B. Investment advisory, investment investment banking, banking, or brokerage brokerage services services C. External auditing services D. Internal audit outsourcing services 83. This section of the Sarbanes-Oxley Act requires requires that public public companies have an audit committee committee that is a subcommittee of the board of directors. A. Section 201 B. Section 301 C. Section 401 D. Section 404
84. This section of the Sarbanes-Oxley Sarbanes-Oxley Act requires that the the CEO, CFO, and and other responsible responsible offices of the company submit a certified statement accompanying each annual and quarterly report acknowledging their responsibility for the contents of the reports and the underlying system of internal controls. A. Section 301 B. Section 401 C. Section 302 D. Section 404 85. This section of the Sarbanes-Oxley Act requires requires that there there be disclosures in periodic reports disclosing any off-balance-sheet transactions, including obligations or arrangements that may impact the financial position of the company. A. Section 201 B. Section 401 C. Section 906 D. Section 404 86. This section of the Sarbanes-Oxley Act requires requires management management assessment assessment and reporting reporting of the company’s internal controls. A. Section 404 B. Section 409 C. Section 301 D. Section 201 87. This section of the Sarbanes-Oxley Sarbanes-Oxley Act requires requires that auditors auditors include, as part of their audit procedures, an attestation to the internal control report prepared by management. management. A. Section 404 B. Section 409 C. Section 301 D. Section 201 88. This section of the Sarbanes-Oxley Sarbanes-Oxley Act requires requires that all public public companies have have in place a code of ethics covering its CFO CFO and other key accounting accounting officers. The code must include include principles that advocate honesty and moral conduct, fairness in financial fi nancial reporting, and compliance with applicable governmental rules and regulations. A. Section 401 B. Section 404 C. Section 406 D. Section 409 89. The section of the the Sarbanes-Oxley Act Act makes it a felony to knowingly alter, destroy, falsify, falsify, or conceal any records or documents documents with the intent to influence an investigation. investigation. This provision relates to both the company and its auditors. A. Section 602 B. Section 802 C. Section 806 D. Section 409
90. Someone who reports instances instances of wrongdoing or assists in a fraud investigation investigation is referred to as a(n): A. Ringer B. External Auditor C. Internal Auditor D. Whistleblower 91. This A. B. C. D.
section of the Sarbanes-Oxley Sarbanes-Oxley Act is referred to as the the “whistleblower protection” protection” provision. Section 201 Section 306 Section 806 Section 1102
92. Which of the following describes describes a difference management management oversight oversight as a result of SarbanesSarbanesOxley? A. Management focus has gone from one of strategic decision decision making and risk management management to overall accountability. B. The board of directors and the audit committee have have a lower level of accountability. accountability. C. Members of upper management management have the opportunity opportunity to focus on overall financial information and can leave the details to subordinates. D. The jobs of management management have been lightened as a result result of the certification certification requirements. 93. Which of the following describes describes a change in internal controls and and compliance as a result of the Sarbanes-Oxley Act? A. The corporate associates associates who are responsible responsible for the development development and maintenance maintenance of the accounting information system have become less important. B. Although there are are new management management reporting requirements, requirements, the financial financial reporting has actually decreased. C. The creation of new new reporting requirements requirements has created created a large amount amount of extra work for accountants, IT departments, and executives. D. A side effect of compliance with the internal internal control sections of the Act has resulted resulted in a decrease in the amount of accounting information. ANSWERS TO TEST BANK – CHAPTER 5 – MULTIPLE CHOICE: 36. B 48. A 60. B 72. C 37. A 49. C 61. C 73. C 38. C 50. B 62. D 74. B 39. D 51. B 63. A 75. C 40. C 52. A 64. D 76. A 41. B 53. D 65. D 77. C 42. D 54. C 66. C 78. A 43. B 55. D 67. B 79. C 44. C 56. B 68. A 80. A 45. A 57. A 69. D 81. C 46. B 58. C 70. D 82. C 47. C 59. D 71. B 83. B
84. 85. 86. 87. 88. 89. 90. 91. 92. 93.
C B A A C B D C A C
TEST BANK - CHAPTER 5 – END OF CHAPTER QUESTIONS 94. Which of the following is not considered a component component of corporate governance? governance? A. Board of Directors Oversight Oversight B. IRS Audits C. Internal Audits D. External Audits 95. Good corporate governance is achieved when the the interests of which which of the following groups are balanced? A. Internal auditors and and external auditors B. Shareholders and regulators C. Shareholders, the corporation, corporation, and and the community D. Regulators and the community 96. Over time, corporate leaders establish trust by being active active leaders, stressing stressing integrity, clarity, and consistency. consistency. This is referred to as: A. Internal control B. Corporate governance C. Fiduciary duty D. Tone at the top 97. Corporate governance is primarily primarily concerned concerned with: A. Enhancing the trend toward more women serving on boards of directors. B. Promoting an increase increase in hostile hostile takeovers. takeovers. C. Promoting the legitimacy of corporate corporate charters. charters. D. Emphasizing the the relative roles, roles, rights, and and accountability of a company’s stakeholders. 98. The governing body responsible for establishing the COSO framework for internal controls evaluations is the: A. Treadway Commission. Commission. B. SEC. C. PCAOB. D. FASB. 99. When financial information is presented presented properly properly and its correctness is verifiable, it is: is: A. Transparent. B. Compliant. C. Accurate. D. Accountable. 100. Which of the following nonaudit services may be performed by auditors for a public-company audit client? A. IT consulting regarding regarding the general ledger ledger system for a newly newly acquired division. B. Programming assistance assistance on the new division’s general general ledger system. system. C. Human resource resource consulting regarding personnel personnel for the new division. D. Income tax return preparation preparation for the new division.
101. Which of the following is not true regarding the requirements for reporting on internal controls under Section 404 of the Sarbanes-Oxley Act of 2002? A. Management must accept responsibility responsibility for the establishment establishment and maintenance maintenance of internal internal controls and provide its assessment of their effectiveness. B. The independent auditor must issue issue a report on management’s management’s assessment assessment of internal controls. C. Management must identify the framework framework used for evaluating evaluating its internal internal controls. D. Management must achieve a control control environment that has no significant significant deficiencies. 102. In the corporate governance chain of command, the audit committee is accountable to: A. The company’s vendors vendors and other creditors. creditors. B. Management and employees. C. Governing bodies such as the SEC and PCAOB. PCAOB. D. The external auditors. 103. Section 806 of the Sarbanes-Oxley Act is often referred to as the whistle-blower protection provision of the Act because: A. It offers stock ownership ownership to those who report report instances of wrongdoing. wrongdoing. B. It specifies that that whistleblowers must be terminated terminated so as as to avoid retaliation. retaliation. C. It protects protects whistleblowers’ whistleblowers’ jobs and prohibits retaliation. D. It provides criminal criminal penalties for the alteration alteration of destruction destruction of documents. documents. 104. Which of the following is true regarding the post-Sarbanes-Oxley role of the corporate leader? A. More emphasis is placed placed on strategic planning planning and less emphasis on financial financial information. B. The corporate leader leader must be more in tune with IT to provide corporate governance governance solutions. C. The corporate leader must be more focused focused on merger merger and acquisition acquisition targets. D. The corporate leader tends to be less involved with the the board of directors. directors. 105. Many corporate frauds involve: A. Managers soliciting assistance from their their subordinates. subordinates. B. A small deceptive act that intensifies intensifies into criminal behavior. behavior. C. An earnings management management motive. D. All of the above. ANSWERS END OF CHAPTER CHAPTER QUESTIONS -TEST -TEST BANK - CHAPTER 5 94. 95. 96. 97.
B C D D
98. 99. 100. 101.
A C D D
102. 103. 104. 105.
C C B D
TEST BANK - CHAPTER 5 – SHORT ANSWER QUESTIONS 106. Why is tone at the top so important to corporate governance? Answer: Tone at the the top is so important important because it is the set of values and behaviors in place for corporate leaders. As the term suggests, it sets the the tone, or pattern, for the entire entire organization. Thus a “bad” tone at the top is likely to filter down and affect all levels of the enterprise. 107 Why do you think companies that practice good corporate governance tend to be successful in business? Answer: Good corporate governance governance means means that the company company leadership is held held accountable for building shareholder value and creating confidence in financial financial reporting processes. This accountability means that corporate leaders leaders are more likely to do the right thing: that is, they operate efficiently, effectively, effectively, and ethically. Such companies companies tend to be more successful. .
108. Which stakeholder group (internal or external) is more likely to be affected by corporate governance, and which has a direct affect on corporate governance? Answer: External stakeholders stakeholders are most affected by corporate corporate governance. Bad Bad corporate governance is likely to lead to negative consequences for external stakeholders such as creditors or stockholders. stockholders. Internal stakeholders stakeholders have have a more more direct effect on the state state of corporate corporate governance. Those external to the company do not have as much influence or control. 109. Explain how it is possible that a shareholder could be considered both an internal and external stakeholder. Answer: Shareholders Shareholders are owners of the company and could could therefore be considered internal; internal; stakeholders. However, in many large corporations, most most shareholders own such a small percentage of outstanding outstanding shares that they they have little to no influence on the corporation. Thus, they could be considered external stakeholders. 110. Why is the Board of Directors considered an internal stakeholder group, when it is required to have members who are independent of the company? Answer: Because Because the board of directors directors has the highest highest level of authority authority with respect to company company objectives and strategies, strategies, it is considered an internal stakeholder stakeholder group. Therefore, it has a direct and strong influence on the governance of the enterprise. 111. How can internal auditors maintain independence, since they are employees of the company? Answer: Internal auditors auditors should not have any reporting relationship relationship or conflicting roles that that impact their objectivity on the job. For example, internal internal auditors often report report to the audit committee so that they are not not reporting to a manager who would lead to a conflict of interest. interest. If internal auditors report to the CEO or CFO, those parties are more likely to have an interest in hiding any fraudulent or unacceptable behavior. 112. Identify the four functions of the corporate governance process. Answer: The four functions functions of the corporate governance process are: are: management oversight, internal controls and compliance, financial stewardship, and ethical conduct.
113. Describe the key connection between tone at the top and management oversight. Answer: Management oversight is the the set of policies and practices practices in place to lead the directorship of the company. This set of policies and practices, if consistently consistently demonstrated by management, management, should set a good tone at the top. 114. Explain the connection between fiduciary duty and financial stewardship. Answer: Fiduciary duty means means that management management has been entrusted entrusted the power to manage manage assets of the corporation, which are in turn owned by the shareholders. shareholders. Financial stewardship is the obligation of the fiduciary to treat these assets with discipline, respect, and accountability. 115. Why is it that many accountants claim that corporate governance was born in the 1930s? Answer: The stock market market crash of 1928 1928 is believed to have been caused by misleading misleading accounting and reporting reporting practices. The federal government government responded by passing passing both the Securities Act of 1933 and the Securities Securities Exchange Act of 1934. 1934. These were the first regulations regulations to attempt to require management accountability accountability to investors, so they are thought of as the birth of corporate governance. 116. What is the primary difference between the Securities Act of 1933 and the Securities Exchange Act of 1934? Answer: The Securities Securities Act of 1933 requires requires full financial disclosure disclosure before securities can be sold, while the Securities Exchange Act of 1934 requires ongoing disclosure for registered companies. 117. Why did the SEC establish the PCAOB? Answer: The PCAOB was established to govern the work of auditors auditors of public companies. companies. The PCAOB provides standards for audits, and has investigative and disciplinary authority over public accounting firms. 118. Why can auditors no longer be involved in helping their audit clients establish accounting information systems? Answer: Around the period period of discussion on the the upcoming Sarbanes-Oxley Sarbanes-Oxley act, there there was a general perception in public that this type of consulting engagement impaired the independence of auditors. There was concern that a firm that that helped design an accounting accounting system could not be independent in assessing the effectiveness and reliability of that accounting system. To enhance independence, the Sarbanes-Oxley Act prohibited such consulting engagements. 119. Under what conditions are auditors permitted to perform non-audit services for their audit clients? Answer: Non-audit services services are permitted only only if the auditor has obtained prior approval from the client’s audit committee. 120. How has the Sarbanes-Oxley Act increased the importance of audit committees in the corporate governance process? Answer: The SOX Act places much more more responsibility on the the audit committee. committee. On financial matters, the audit committee is to supervise the board of directors, which in turn supervises corporate management. management. The audit committee must must be independent and it is responsible responsible for hiring, firing, and overseeing overseeing the external auditors. auditors. The external external auditors report to the the audit committee on all audit related matters. matters. Some companies may have followed followed these practices prior to 2002, but SOX now requires the use of these practices.
121. Identify the six financial matters that must be certified by a company’s top officers under the requirements of Section 302 of the Sarbanes-Oxley Act. Answer: The following matters matters must be certified certified by a company’s top officers: (1) the signing signing officers have reviewed the report in detail; (2) based on the signing officer’s knowledge, the report does not misstate any facts; (3) based on the signing officer’s knowledge, the financial statements and related disclosures are fairly presented; (4) the signing officers are responsible for the establishment, maintenance, maintenance, and effectiveness of internal controls; (5) the signing officers have disclosed to the auditors and audit committee any instances of fraud or internal control deficiencies; (6) the signing officers indicate whether or not any significant changes in internal controls have occurred since the date of their most recent evaluation. 122. Explain the relationship between Section 401 of the Sarbanes-Oxley Act and the concept of transparency. Answer: Transparency Transparency in financial reporting implies implies that nothing nothing is hidden from the view of readers of financial statements. statements. Section 401 requires requires new disclosure information on the financial financial statements for off-balance-sheet transactions. This ensures that off-balance-sheet transactions are not hidden from readers. 123. Explain the difference between management’s responsibility and the company’s external auditors’ responsibility regarding the company’s internal controls under Section 404 of the Sarbanes-Oxley Act. Answer: Under section 404 of the SOX Act, the CEO and CFO have the the responsibility to maintain maintain a proper system of internal control. Management Management must assess the effectiveness effectiveness of the internal internal control system based on an established established framework such as COSO. COSO. The external auditor must must review the internal controls and attest to the effectiveness of the internal controls. 124. Explain why Section 409 of the Sarbanes-Oxley Act has placed more pressure on members of IT departments within public companies. Answer: Section 409 409 of the SOX Act requires real-time disclosures of important important corporate events such as bankruptcy, new contracts, acquisitions and disposals, and changes in control. This real-time reporting requires that the company’s accounting systems track such events in real-time. Therefore, IT departments departments must help establish and maintain maintain IT systems capable of achieving these reporting requirements. 125. How is the Sarbanes-Oxley Act forcing corporations to become more ethical? Answer: The SOX SOX Act requires all public public companies to have a code of ethics in place. This does not guarantee that ethical conduct will occur, but it at least informs managers and employees that they are expected to act ethically. 126. Why do corporate leaders see their jobs as more risky since the Sarbanes-Oxley Act became effective? Answer: There are several “sign-offs” that that corporate leaders must do. If a corporate officer signssignsoff without due care or fraudulently, he or she can be subject to penalties. 127. Which governing body holds the top position of management oversight? Answer: The corporate corporate board of directors holds holds the top management management oversight position.
128. Identify two ways that companies are making efforts to improve the financial stewardship of their managers. Answer: In order to improve the financial stewardship stewardship of their managers, managers, some companies companies are offering training programs to assist managers in understanding their stewardship responsibilities and some have made adjustments to management management incentive compensation packages to reduce the temptation to manage earnings. 129. How can IT departments assist corporate managers in fulfilling their corporate governance roles? Answer: A company’s IT infrastructure is a very important system system for allowing management management access to the information they need to ensure compliance with corporate governance guidelines. The IT system can also help ensure managers and employees are trained on ethics and corporate governance. The chapter mentions mentions the example of BASF that supplies ethics ethics training via the Internet. 130. How is it i t that management’s role as financial stewards may be considered a conflict of interest with their position as employees of the company? Answer: Managers often often have compensation compensation plans in which incentives are tied tied to company earnings. This may lead to a conflict between what what is in the best interest of shareholders shareholders and the best interest of the manager manager or employees. Often what is in the best interest of employees employees or management is not in the best interest of the shareholders. TEST BANK - CHAPTER 5 – SHORT ESSAY 131. Why are shareholders sometimes considered internal stakeholders and sometimes considered external stakeholders? Answer: Shareholders are owners of the company and could therefore therefore be considered considered internal stakeholders. However, in many large corporations, corporations, most most shareholders own such such a small percentage of outstanding shares shares that they have little to to no influence on the corporation. Thus, they could be considered external stakeholders. 132. Is it possible for financial information to be accurate accurate but not transparent? transparent? Similarly, is it possible for financial information information to be transparent transparent but not accurate? accurate? Explain. Answer: Yes, it is possible possible for information to be accurate but not not transparent. transparent. For example, if a company accurately reports information on the face of the financial statements but neglects to disclose appropriate explanatory information in the footnotes, f ootnotes, then transparency transparency is compromised. On the other hand, a company can be thorough in providing provi ding supplementary information that is needed to understand and analyze the financial statement amounts, even though there are errors in the reporting of those amounts.
133. Earnings management involves lying about the company’s financial results in order to provide a more favorable impression to investors. Earnings management is discussed in the section on financial stewardship. Explain how the other three three functions of corporate governance can can work together to help prevent earnings management within a corporation. Answer: Besides financial financial stewardship the the other three functions of corporate governance are management oversight, internal controls and compliance, and ethical conduct. Even if there are weaknesses in financial stewardship that allow for the possibility of earnings management, management, these other three functions should prevent this. If effective management oversight is practiced whereby supervision and communication are key to the ongoing processes, manipulations of financial information should be caught by the diligent managers who oversee the financial reporting function. In addition, the system of internal controls should provide for the assignment of rights and responsibilities and compliance with accounting conventions in a manner that encourages accuracy and transparency transparency of financial information. information. Furthermore, creating and maintaining maintaining a culture of honesty and accountability is inconsistent with the practice of earnings management. Accordingly, these strengths strengths of the other other components of corporate corporate governance are are expected to overcome any weakness in financial stewardship that might create an opportunity for earnings management. 134. Describe how the characteristics of the financial markets in the 1980s eventually led to the creation of the Sarbanes-Oxley Act of 2002. Answer: In the 1980s, 1980s, there was was intense pressure pressure for companies to met or beat their their earnings targets. As a result, creative accounting practices became more common. Even in the following fol lowing decade, these irregularities became so severe that a series of high-profile corporate accounting scandals erupted. The losses suffered as a result of these corporate scandals were so significant that many investors demanded that new legislation be introduced in order to prevent repeat instances of these problems. The SOX Act was the result. 135. Although the Sarbanes-Oxley Act of 2002 applies to public companies, many private business organizations have been impacted by this legislation, especially if they are suppliers to a public company. Explain how this external external stakeholder relationship can lead lead to the widespread widespread application of Section 404 of the Act. Answer: For many of the public public companies which which are doing business business with private companies, companies, the requirements of the SOX Act are being being superimposed upon the private companies. companies. In order for the public company to comply with the SOX Act, it must be assured that its trading partners also maintain effective controls. As a result, many private companies are complying with the SOX Act in order to protect their business relationships. 136. Describe at least three ways that the Sarbanes-Oxley Act and the increased emphasis on corporate governance have put more attention on the role of those responsible for the company’s accounting information systems. Answer: IT departments departments are expected to help help management management achieve compliance compliance with new legislation by leveraging technology so that financial processes can be relied upon to provide accurate information. Secondly, many corporate managers are demanding more electronic recordkeeping to provide timely information, but that requires an IT infrastructure that supports the company’s strategies strategies and goals. Finally, since most corporate managers managers do not have time to collect data, they need to have information that is readily accessible.
137. Why do you think it is particularly challenging for companies to maintain ethical behavior during difficult financial times? Answer: During difficult financial financial times, it is particularly particularly challenging for companies to maintain maintain ethical behavior because of the conflict of interest for managers in their role as financial stewards of the business. Management may may be inclined to act in a way that protects their job or their employees at the expense of the shareholders. Earnings management management techniques are an easy solution to this conflict. TEST BANK - CHAPTER 5 – Problems 138. List the six steps for establishing internal controls and describe how this process leads to stronger overall corporate governance. Answer: The six-step six-step process for internal controls controls includes the following: 1. Define the key activities and resources involved in each business activity. 2. Define the objectives of each activity. 3. Obtain input from experienced users and advisors on the effective design of controls. 4. Formally and thoroughly document the details of the controls. 5. Test the effectiveness of controls to make sure they are operating as designed. 6. Engage in continuous improvement to fix problems and upgrade controls. These steps help to establish a thorough understanding of processes as the foundation for an effective system. It also provides for documenting, monitoring, and improving the system as needed. This provides for accurate and transparent financial reporting. 139. List the items that must be certified by corporate management management in accordance with the provisions of the Sarbanes-Oxley Sarbanes-Oxley Act. Discuss how these responsibilities have likely changed the period-to-period activities of the certifying managers. Answer: Top managers managers must submit a certified statement statement to accompany accompany each annual and and quarterly report to acknowledge their responsibility for the contents of the financial reports and the underlying system of internal i nternal controls. The specific points include acknowledgments that: 1. They have reviewed the report in detail. 2. The report does not misstate any facts. 3. The financial statements and related disclosures are fairly presented. 4. They are responsible for the establishment, maintenance, maintenance, and effectiveness of internal controls. 5. They have disclosed any instances of fraud or internal control deficiencies. 6. They have indicated whether or not any significant changes in internal controls have occurred since the date of their most recent evaluation. The responsibilities inherent in these certified statements have likely resulted in significant changes in the activities activities of the signing signing officers. Specifically, the certifying officers officers can no longer delegate responsibility for the detailed accounting functions to their subordinates. These officers must become knowledgeable about the details in order to facilitate these certifications. Moreover, since the certifications must be filed fil ed quarterly, this new attention to detailed accounting information must be a continuous responsibility.
140. Identify the costs and benefits benefits of complying with the Sarbanes-Oxley Sarbanes-Oxley Act of 2002. Do you think the costs are justified? Answer: The costs of complying complying with SOX are are high, and have ranged from some companies’ complete overhaul of operations to other companies’ mere revisions in reporting and documentation. In addition, most companies have have also seen increases in their their audit costs, as auditors also have increased responsibilities as a result of SOX. On the other hand, some companies have realized benefits from the requirements of SOX, including enhanced performance as a result of improved internal controls. Students’ responses responses to the question of SOX’s justification justification are likely to be mixed. Some may criticize SOX for its extreme requirements and minimal benefits, as well as the resulting shift in managerial focus from large scale, strategic issues to detailed reporting requirements. They may agree that SOX was enacted hastily in response to a few bad cases of corruption that are not necessarily representative of America’s corporate control environment as a whole. However, others may appreciate the opportunity that SOX has presented for improving corporate controls. Some SOX proponents believe that the benefits are likely to be realized gradually as companies increase their awareness of internal controls and streamline their business processes accordingly. 141. Using an Internet search engine (such as Google, Dogpile, Lycos), determine determine who was the whistleblower at Enron. Summarize the circumstances. circumstances. What was was the relationship of this person with the company? Was this an internal or external external stakeholder? Answer: The whistleblower whistleblower at Enron was Sherron Sherron Watkins, an internal stakeholder stakeholder who held the the position of Vice President for Corporate Development. In 2001, she wrote a letter to Enron founder Ken Lay to warn him of the company’s impending financial problems if he did not come clean about potentially disastrous accounting tricks. She also shared her concerns with a friend at Arthur Anderson, her her former employer and and Enron’s audit firm. 142. Using an Internet search engine (such as Google, Dogpile, Lycos), search for the terms “guilty as charged” + “California Micro Devices” in order to find an article about the company, California Micro Devices. Identify the related corporate governance issues. issues. Answer: Two top-ranking executives at California California Micro Devices were were convicted of accounting accounting fraud, including securities fraud and insider trading. As top executives, they were in a position of trust. The federal prosecutors in their case case indicated that it was important important to send a message about the seriousness of their crimes, the importance of their roles within the company, and the need for severe punishment for the abusive accounting schemes that were carried out.
143. There are five types of management management earnings techniques techniques presented in this this chapter. Provide two or three specific examples of how corporate leaders could pull off these types of fraud, as well as the internal control activities that could be used to prevent them. Answer: Student responses are are likely to vary but may include include the following fraud fraud schemes, each each of which may be particularly effective if conducted near year-end: Early recognition of revenues, such as when management loads the sales pipeline with customer transactions that will actually be carried out in the next accounting period rather than the current period; i.e., channel stuffing. Early shipment of products, such as when management authorizes authorizes premature shipment of goods to customers. This is often done for customers who place routine or recurring orders, so management assumes assumes that it will be able to pull off this accounting stunt by sending a shipment for a transaction transaction that has not yet been taken taken place. Even if the customer refuses the shipment and returns the goods, such is likely to occur in the next accounting period, so the fraudulent sale would still be recorded in the current period. Falsification of customers, such as when bogus customers are created in the accounting records and bogus sales transactions are developed to inflate the company’s revenues. Fictitious supporting documents may be created to give the impression of a legitimate transaction with a valid customer. Falsification of invoices or other records may occur in an attempt to force more sales transactions into the current current period’s accounting records. records. For instance, sales invoices and related shipping documents may be backdated so that they are included in the prior period. Allowing customers to to take products without without taking title to the products, such as forcing a trial period upon them. Management Management may attempt this, hoping that that the customers may decide to carry out the transaction. Even if the customer returns the goods, such is likely to occur in the next accounting period, so the fraudulent shipment and sales would still be recorded in the current period. •
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