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ACCOUNTING INFORMATION 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 governance tend to be rewarded with
higher rates of return and a lower cost of capital.

2. The high cost related to corporate governance far outweighs any of the related benefits.

3. The purpose of corporate governance is to encourage the efficient use of resources and to
require accountability of those resources.

4. The various groups whose interests are related to corporate governance will generally have no
conflicts with each other.

5. In order to be considered a stakeholder in corporate governance, the participant must be


external.

6. The management group tends to have an indirect impact on corporate governance, while the
business community tends to have a direct affect.

7. Even though shareholders are identified as internal stakeholders, they are often regarded as
external stakeholders because of the lack of involvement.

8. Top management is made up of managers who coordinate a number of different departments


or groups within a company and lead the supervisors in their area of responsibility.

9. The management team of a corporation is often divided into three layers – top management,
middle management, and supervisors.

10. The external 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 people and organizations within a community are not directly related to a
corporation, they would still be considered one of the stakeholders.

12. Internal auditors should not allow any financial connections to influence the decisions they
make about the company’s financial statements or disclosures.

13. Good management oversight involves leaders who are good communicators - responsive to
both those above and below in the chain of command.

14. The goal of corporate governance, with respect to internal controls and compliance, is to
ensure that financial information is accurate and transparent.
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15. Maintaining effective internal controls and ensuring compliance is a six-step process which
does not require continual monitoring.

16. Earnings management tends to have a snowball effect, which means that once it is started, it
is necessary to continue the process in order to avoid a negative result.

17. Earnings management is not unethical because it will result in a higher return for the
shareholders.

18. Because of its widespread relevance, ethical conduct is often valued as the most important
part of corporate governance.

19. Prior to the passage of the Sarbanes-Oxley Act, an auditing firm was prohibited from providing
non-audit services to their clients.

20. Before the passage of the Sarbanes-Oxley Act it was common for auditors to perform many
non-audit services for their customers.

21. Non-audit services are now prohibited because of the potential to impair the auditor’s
objectivity.

22. Even though non-audit services are prohibited by Sarbanes-Oxley, the auditor may perform
income tax services for their audit clients if they are pre-approved by the CEO.

23. The auditors report directly to the Board of Directors.

24. The Audit Committee is responsible for hiring, firing, and overseeing the audit firm and serving
as the liaison between the audit firm and management.

25. In order to remain independent, members of the audit committee must receive compensation
from the company for their service to the company.

26. If an officer of a public company fails to certify financial reports or certifies 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 Act contains a section referred to as the “whistle-blower protection”
section that is intended to protect a whistleblower from retaliation by the company or its
employees.

28. The audit committee is the point of contact on financial matters and serves as the supervisor
of the board of directors.

29. Corporate management serves as supervisors to the board of directors.

30. Sarbanes-Oxley has resulted in increased levels of responsibility for business leaders at all
levels.
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31. Even if top managers are intent to do wrong, it is likely that an organization could develop a
set of checks and balances that could completely prevent them from doing so.

32. Data mining software has become more important to corporate governance because of its
ability to help signal frauds.

33. When managers are faced with decision making in troubled times, it is necessary for them to
protect as many jobs as possible, regardless of the impact on individual shareholders.

34. It is not necessary for the audit committee to maintain independence, as long as they are
performing their duties in the proper manner.

35. In today’s business environment, there is not a substitute for the integrity and ethics of a
company’s leaders.

ANSWERS TO TEST BANK – CHAPTER 5 – TRUE / FALSE:

1. T 8. F 15. F 22. F 29. F


2. F 9. T 16. T 23. F 30. T
3. T 10. F 17. F 24. T 31. F
4. F 11. T 18. T 25. F 32. T
5. F 12. F 19. F 26. F 33. F
6. F 13. T 20. T 27. T 34. F
7. T 14. T 21. T 28. T 35. T

TEST BANK - CHAPTER 5 - MULTIPLE CHOICE

36. Which of the following groups would use factors such as those that affect 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 the role of corporate leaders to provide a good
rate of return.
A. Financiers
B. Economists
C. Accountants
D. Lawyers
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38. This group of business would tend to emphasize the role of corporate leaders as providing
effective internal controls and accurate records.
A. Financiers
B. Economists
C. Accountants
D. Lawyers

39. A system of checks and balances where a company’s leadership is held 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 ingredients in the concept of corporate governance include:


A. Motivation of leaders
B. Providing high rates of return and low costs of capital
C. Building value and creating confidence
D. Efficient use of resources

41. The set of values and behaviors in place for the corporate leaders is referred to as:
A. Corporate Governance
B. Tone at the Top
C. Internal Control
D. Stakeholders

42. There are a number of different 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 in the business are
referred to as:
A. Employees
B. Stakeholders
C. Executives
D. Shareholders

44. The group of people who participate in or with the business in a manner that puts them in a
position of financial interest or risk, or is otherwise significant to the overall strategies and
operations of a business are called:
A. Managers
B. Board of Directors
C. Stakeholders
D. Audit Committee
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45. The internal stakeholders would not include:


A. Creditors
B. Shareholders
C. Internal Auditors
D. Audit Committee

46. The internal stakeholders who own a portion of the corporation are called:
A. Directors
B. Shareholders
C. Audit Board
D. Executives

47. This group of stakeholders should have the highest level of authority related to the company’s
objectives and strategies. Elected by the shareholders, it’s role is to align the interests of the
shareholders and management.
A. Audit Committee
B. Internal Auditors
C. Board of Directors
D. Executive Branch

48. This group of stakeholders is responsible for financial matters, including reporting, controls, and
the audit function.
A. Audit Committee
B. External Auditors
C. Board of Directors
D. Internal Auditors

49. Which of the following properly identifies the top management level of the management team?
A. Guide the work of a number of employees doing similar tasks within a department or
group.
B. Coordinate a number of different departments within the company by overseeing
supervisors.
C. Made up of the company’s president and chief executive officer.
D. Carry out the day-to-day operations and administrative functions of the company.

50. This group of stakeholders help management establish and monitor the internal controls for the
company. They rotate throughout the company, reviewing policies, procedures, and 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
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51. People and organizations outside the corporation who have a financial 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?


A. Audit Committee
B. External Auditors
C. Governing Bodies
D. Customers

53. The purpose of this group of stakeholders is to add credibility to the financial 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 applicable financial accounting standards in
the United States:
A. COSO
B. SEC
C. FASB
D. IASB

55. This governing group is responsible for establishing applicable financial accounting standards
globally:
A. COSO
B. SEC
C. FASB
D. IASB

56. This governing group is the federal regulatory agency responsible for protecting the 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 governing group created the framework for internal controls evaluations:
A. COSO
B. SEC
C. FASB
D. IASB
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58. It is necessary that certain stakeholders remain independent related to the corporation’s
financial reporting. Which of the following correctly states the stakeholders that should remain
independent?
A. Internal Auditors, Audit Committee 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 and balances in corporate governance includes several interrelated
functions. Which of the following is not one of those functions?
A. Management Oversight
B. Financial Stewardship
C. Ethical Conduct
D. Governing Bodies

60. The concept that encompasses the policies and procedures in place to lead the directorship of
the company is called:
A. Financial Stewardship
B. Management Oversight
C. Ethical Conduct
D. Internal Controls and Compliance

61. Which of the following is not typical relationship in an organization chart?


A. Supervisors report to managers
B. Managers report to officers
C. Managers report to supervisors
D. Officers report to the board of directors

62. According to the authors, the downfall of Enron involved poor management oversight, and
included the following criticism(s) of the board of directors:
A. Board meetings were few and brief
B. They did not challenge the company’s aggressive accounting policies
C. Board allowed senior executives to be exempted from the company’s policies regarding
conflicts of interest
D. All of the above

63. The correctness of the financial information presented is called:


A. Accuracy
B. Transparency
C. Stewardship
D. Fiduciary

64. This characteristic of financial information, relates to how clearly the information can be
understood. It requires a straightforward, consistent, and timely approach.
A. Accuracy
B. Financial Stewardship
C. Fiduciary Duty
D. Transparency
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65. Companies that emphasize accuracy and transparency:


A. Will have internal controls in place to make sure that their financial reports do not
contradict each other.
B. Will have fewer opportunities for errors or fraud.
C. Will be more likely to prevent opportunities for wrongdoers to cross the line into fraud.
D. All of the above.

66. A special obligation of trust, especially with respect to the finances of another, is called:
A. Financial Stewardship
B. Fiscal Transparency
C. Fiduciary Duty
D. Internal Controls

67. Within the corporate environment, this term means that management has been 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 manner in which an agent handles the affairs and/or finances of another is referred to as:
A. Financial Stewardship
B. Fiscal Transparency
C. Accuracy
D. Fiduciary

69. The most important factors for success in a leader in fulfilling the duty of financial stewardship
are:
A. Financial Stewardship and Fiscal Transparency
B. Financial Accuracy and Internal Control
C. Fiduciary Duty and Ethical Conduct
D. Good Communication and Open Dialogue

70. In order for an environment to thrive where corporate leaders can be good financial stewards:
A. Well-defined rules and procedures must be in place for decision making.
B. It is necessary to consider objectives at the starting point.
C. Any decision made must be in the best interest of the shareholders.
D. All of the above.

71. The act of manipulating financial information in such a way as to shed 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
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72. Which of the following is not one of the typical earnings management techniques?
A. Early revenue recognition
B. Falsification of customers
C. Creation of non-existent vendors
D. Early shipment of products

73. According to the authors, the origin of the corporate governance concept in the United States
coincides with:
A. The passage of Sarbanes-Oxley Act
B. The creation of the Public Company Accounting Oversight Board
C. The establishment of the SEC and enactment of the securities laws
D. The Treadway Commission and the ultimate creation of COSO

74. The Securities Act of 1933 requires:


A. The implementation of a proper climate of internal controls
B. The full disclosure of financial information through the filing of registration statements
before the securities can be sold
C. Ongoing disclosures for registered companies, in addition to the regulation stock
exchanges, brokers, and dealers.
D. The legislation enacted to combat deceptive accounting practices by banks and financial
institutions

75. The Securities Exchange Act of 1934 requires:


A. The implementation of a proper climate of internal controls
B. The full disclosure of financial information through the filing of registration statements
before the securities can be sold
C. Ongoing disclosures for registered companies, in addition to the regulation stock
exchanges, brokers, and dealers.
D. The legislation enacted to combat deceptive accounting practices by banks and financial
institutions

76. The establishment of the SEC and the enactment of securities laws were responses to:
A. The stock market crash of 1929 and the Great Depression of the 1930s
B. Market pressures during the 1980s
C. Increased inflation and cost of capital during the 1970s
D. High-profile accounting scandals in the early 2000s

77. This legislation was enacted in an effort to curb the corruption and accounting blunders that had
been discovered in connection with the bankruptcies of corporate giants, such as WorldCom.
A. Securities Exchange Act
B. US Patriot Act
C. Sarbanes-Oxley Act
D. Securities Act
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78. The PCAOB was established to carry the provisions of the:


A. Sarbanes-Oxley Act
B. Securities Act
C. US Patriot Act
D. Securities Exchange Act

79. The Sarbanes-Oxley Act relates to:


A. Private companies and auditors of public companies
B. Public companies
C. Auditors of public companies and public companies
D. Auditors of private companies

80. Auditors of public companies are now prohibited from providing non-audit 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 Act relates to auditor independence and includes items such as:
A. Requiring the lead partner on a public company audit to rotate off the engagement each
year.
B. If an auditor is hired away from the audit firm to take a job with the client, 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 with the design of the client’s accounting information system
and expands into areas of IT system development, then the auditor is considered to have
impaired independence.
D. Auditors of public companies are now allowed to provide non-audit services to their audit
clients.

82. Which of the following is not considered to be a non-audit service?


A. Preparation of accounting records and financial statements
B. Investment advisory, investment banking, or brokerage services
C. External auditing services
D. Internal audit outsourcing services

83. This section of the Sarbanes-Oxley Act requires that public companies have an audit committee
that is a subcommittee of the board of directors.
A. Section 201
B. Section 301
C. Section 401
D. Section 404
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84. This section of the Sarbanes-Oxley Act requires that the CEO, CFO, and other 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 that 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 management assessment and 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 Act requires that auditors include, as part of their audit
procedures, an attestation to the internal control report prepared by management.
A. Section 404
B. Section 409
C. Section 301
D. Section 201

88. This section of the Sarbanes-Oxley Act requires that all public companies have in place a code of
ethics covering its CFO and other key accounting officers. The code must include principles that
advocate honesty and moral conduct, fairness in financial 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 Sarbanes-Oxley Act makes it a felony to knowingly alter, destroy, falsify, or
conceal any records or documents with the intent to influence an investigation. This provision
relates to both the company and its auditors.
A. Section 602
B. Section 802
C. Section 806
D. Section 409
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90. Someone who reports instances of wrongdoing or assists in a fraud investigation is referred to
as a(n):
A. Ringer
B. External Auditor
C. Internal Auditor
D. Whistleblower

91. This section of the Sarbanes-Oxley Act is referred to as the “whistleblower protection” provision.
A. Section 201
B. Section 306
C. Section 806
D. Section 1102

92. Which of the following describes a difference management oversight as a result of Sarbanes-
Oxley?
A. Management focus has gone from one of strategic decision making and risk management
to overall accountability.
B. The board of directors and the audit committee have a lower level of accountability.
C. Members of upper management have the opportunity to focus on overall financial
information and can leave the details to subordinates.
D. The jobs of management have been lightened as a result of the certification requirements.

93. Which of the following describes a change in internal controls and compliance as a result of the
Sarbanes-Oxley Act?
A. The corporate associates who are responsible for the development and maintenance of the
accounting information system have become less important.
B. Although there are new management reporting requirements, the financial reporting has
actually decreased.
C. The creation of new reporting requirements has created a large amount of extra work for
accountants, IT departments, and executives.
D. A side effect of compliance with the internal control sections of the Act has 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 84. C
37. A 49. C 61. C 73. C 85. B
38. C 50. B 62. D 74. B 86. A
39. D 51. B 63. A 75. C 87. A
40. C 52. A 64. D 76. A 88. C
41. B 53. D 65. D 77. C 89. B
42. D 54. C 66. C 78. A 90. D
43. B 55. D 67. B 79. C 91. C
44. C 56. B 68. A 80. A 92. A
45. A 57. A 69. D 81. C 93. C
46. B 58. C 70. D 82. C
47. C 59. D 71. B 83. B
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TEST BANK - CHAPTER 5 – END OF CHAPTER QUESTIONS

94. Which of the following is not considered a component of corporate governance?


A. Board of Directors Oversight
B. IRS Audits
C. Internal Audits
D. External Audits

95. Good corporate governance is achieved when the interests of which of the following groups are
balanced?
A. Internal auditors and external auditors
B. Shareholders and regulators
C. Shareholders, the corporation, and the community
D. Regulators and the community

96. Over time, corporate leaders establish trust by being active leaders, stressing integrity, clarity,
and 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 concerned with:


A. Enhancing the trend toward more women serving on boards of directors.
B. Promoting an increase in hostile takeovers.
C. Promoting the legitimacy of corporate charters.
D. Emphasizing the relative roles, rights, 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.
B. SEC.
C. PCAOB.
D. FASB.

99. When financial information is presented properly and its correctness is verifiable, it 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 the general ledger system for a newly acquired division.
B. Programming assistance on the new division’s general ledger system.
C. Human resource consulting regarding personnel for the new division.
D. Income tax return preparation for the new division.
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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 for the establishment and maintenance of internal
controls and provide its assessment of their effectiveness.
B. The independent auditor must issue a report on management’s assessment of internal
controls.
C. Management must identify the framework used for evaluating its internal controls.
D. Management must achieve a control environment that has no significant deficiencies.

102. In the corporate governance chain of command, the audit committee is accountable to:
A. The company’s vendors and other creditors.
B. Management and employees.
C. Governing bodies such as the SEC and 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 to those who report instances of wrongdoing.
B. It specifies that whistleblowers must be terminated so as to avoid retaliation.
C. It protects whistleblowers’ jobs and prohibits retaliation.
D. It provides criminal penalties for the alteration of destruction of documents.

104. Which of the following is true regarding the post-Sarbanes-Oxley role of the corporate leader?
A. More emphasis is placed on strategic planning and less emphasis on financial information.
B. The corporate leader must be more in tune with IT to provide corporate governance
solutions.
C. The corporate leader must be more focused on merger and acquisition targets.
D. The corporate leader tends to be less involved with the board of directors.

105. Many corporate frauds involve:


A. Managers soliciting assistance from their subordinates.
B. A small deceptive act that intensifies into criminal behavior.
C. An earnings management motive.
D. All of the above.

ANSWERS END OF CHAPTER QUESTIONS -TEST BANK - CHAPTER 5

94. B 98. A 102. C


95. C 99. C 103. C
96. D 100. D 104. B
97. D 101. D 105. D
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TEST BANK - CHAPTER 5 – SHORT ANSWER QUESTIONS

106. Why is tone at the top so important to corporate governance?


Answer: Tone at the top is so important because it is the set of values and behaviors in place for
corporate leaders. As the term suggests, it sets the tone, or pattern, for the 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 means that the company leadership is held accountable for
building shareholder value and creating confidence in financial reporting processes. This
accountability means that corporate leaders are more likely to do the right thing: that is, they
operate efficiently, effectively, and ethically. Such 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 are most affected by corporate governance. Bad corporate
governance is likely to lead to negative consequences for external stakeholders such as creditors
or stockholders. Internal stakeholders have a more direct effect on the state of 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 are owners of the company and could therefore be considered internal;
stakeholders. However, in many large corporations, most shareholders own such a small
percentage of outstanding shares that 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 the board of directors has the highest level of authority with respect to company
objectives and strategies, it is considered an internal 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 should not have any reporting relationship or conflicting roles that
impact their objectivity on the job. For example, internal auditors often report to the audit
committee so that they are not reporting to a manager who would lead to a conflict of 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 of the corporate governance process are: management oversight,
internal controls and compliance, financial stewardship, and ethical conduct.
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113. Describe the key connection between tone at the top and management oversight.
Answer: Management oversight is the set of policies and practices in place to lead the directorship
of the company. This set of policies and practices, if consistently demonstrated by management,
should set a good tone at the top.

114. Explain the connection between fiduciary duty and financial stewardship.
Answer: Fiduciary duty means that management has been entrusted the power to manage assets
of the corporation, which are in turn owned by the 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 crash of 1928 is believed to have been caused by misleading
accounting and reporting practices. The federal government responded by passing both the
Securities Act of 1933 and the Securities Exchange Act of 1934. These were the first regulations
to attempt to require management 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 Act of 1933 requires full financial 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 of public 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 of discussion on the upcoming Sarbanes-Oxley act, 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 helped design an 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 are permitted 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 responsibility on the audit committee. On financial
matters, the audit committee is to supervise the board of directors, which in turn supervises
corporate management. The audit committee must be independent and it is responsible for
hiring, firing, and overseeing the external auditors. The external auditors report to the audit
committee on all audit related matters. Some companies may have followed these practices prior
to 2002, but SOX now requires the use of these practices.
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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 must be certified by a company’s top officers: (1) the 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, 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 in financial reporting implies that nothing is hidden from the view of
readers of financial statements. Section 401 requires new disclosure information on the 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 responsibility to maintain a
proper system of internal control. Management must assess the effectiveness of the internal
control system based on an established framework such as COSO. The external auditor 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 of the SOX Act requires real-time disclosures of 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 must help establish and 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 Act requires all 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 corporate leaders must do. If a corporate officer signs-
off 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 board of directors holds the top management oversight position.
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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 of their managers, some companies are
offering training programs to assist managers in understanding their stewardship responsibilities
and some have made adjustments to 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 for allowing 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 the example of BASF that supplies ethics training via the
Internet.

130. How is it 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 have compensation plans in which incentives are tied to company
earnings. This may lead to a conflict between what is in the best interest of shareholders and the
best interest of the manager or employees. Often what is in the best interest of 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 be considered internal
stakeholders. However, in many large corporations, most shareholders own such a small
percentage of outstanding shares that they have little to no influence on the corporation. Thus,
they could be considered external stakeholders.

132. Is it possible for financial information to be accurate but not transparent? Similarly, is it possible
for financial information to be transparent but not accurate? Explain.
Answer: Yes, it is possible for information to be accurate but not 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, then transparency is compromised.
On the other hand, a company can be thorough in providing supplementary information that is
needed to understand and analyze the financial statement amounts, even though there are errors
in the reporting of those amounts.
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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 functions of corporate governance can work
together to help prevent earnings management within a corporation.
Answer: Besides financial stewardship 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, 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 of financial information. Furthermore, creating and maintaining a
culture of honesty and accountability is inconsistent with the practice of earnings management.
Accordingly, these strengths of the other components of corporate governance 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, there was intense pressure for companies to met or beat their earnings
targets. As a result, creative accounting practices became more common. Even in the following
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 stakeholder relationship can lead to the widespread
application of Section 404 of the Act.
Answer: For many of the public companies which are doing business with private companies, the
requirements of the SOX Act are being superimposed upon the private 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 are expected to help management achieve 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 and goals. Finally, since most corporate managers do not have time to
collect data, they need to have information that is readily accessible.
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137. Why do you think it is particularly challenging for companies to maintain ethical behavior during
difficult financial times?
Answer: During difficult financial times, it is particularly challenging for companies to maintain
ethical behavior because of the conflict of interest for managers in their role as financial stewards
of the business. Management may be inclined to act in a way that protects their job or their
employees at the expense of the shareholders. Earnings 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 process for internal 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 in accordance with the
provisions of the Sarbanes-Oxley Act. Discuss how these responsibilities have likely changed
the period-to-period activities of the certifying managers.
Answer: Top managers must submit a certified statement to accompany each annual and
quarterly report to acknowledge their responsibility for the contents of the financial reports
and the underlying system of internal 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, 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 of the signing officers. Specifically, the certifying 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 quarterly, this new attention to detailed accounting
information must be a continuous responsibility.
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140. Identify the costs and benefits of complying with the Sarbanes-Oxley Act of 2002. Do you think
the costs are justified?
Answer: The costs of complying with SOX 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 also seen increases in 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 to the question of SOX’s 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 who was the
whistleblower at Enron. Summarize the circumstances. What was the relationship of this
person with the company? Was this an internal or external stakeholder?
Answer: The whistleblower at Enron was Sherron Watkins, an internal stakeholder who held 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 former employer 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.
Answer: Two top-ranking executives at California Micro Devices were convicted of accounting
fraud, including securities fraud and insider trading. As top executives, they were in a position of
trust. The federal prosecutors in their case indicated that it was 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.
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143. There are five types of management earnings techniques presented in 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 likely to vary but may include the following fraud schemes, 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 premature shipment of
goods to customers. This is often done for customers who place routine or recurring
orders, so management assumes that it will be able to pull off this accounting stunt by
sending a shipment for a transaction that has not yet been 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 period’s accounting records. For instance, sales invoices and
related shipping documents may be backdated so that they are included in the prior
period.
• Allowing customers to take products without taking title to the products, such as forcing a
trial period upon them. Management may attempt this, hoping 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.