Chapter 12 Business Ethics, Fraud, and Fraud Detection

Review Questions:
1. What is ethics?
Response: Ethics pertains to the principles of conduct that individuals
use in making choices and guiding their behavior in situations that
involve the concepts of right and wrong.
2. What is business ethics?
Response: Business ethics involves finding the answers to two
questions:
(1) How do managers decide what is right in conducting their business?
(2) Once managers have recognized what is right, how do they achieve
it?
3. What are the four areas of ethical business issues?
Response: equity, rights, honesty, and the exercise of corporate power
4. What are the main issues to be addressed in a business code of
ethics required by the Securities and Exchange Commission?
Response: conflicts of interest, full and fair disclosures, legal
compliance, internal reporting of code violations, and accountability
5. What are three ethical principles that may provide some
guidance for ethical responsibility?
Response: proportionality, justice, and minimization of risk

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 6. What is computer ethics?
Response: Computer ethics is “the analysis of the nature and social
impact of computer technology and the corresponding formulation and
justification of policies for the ethical use of such technology..
7. How do the three levels of computer ethics—pop, para, and
theoretical—differ?
Response: The lowest level of computer ethics—pop—merely reflects
the exposure to stories and reports regarding the ramifications of
computer technology, such as computer viruses (bad ramifications) and
educational enhancements for handicapped individuals (good
ramifications).
The next level—para—requires a little more involvement in learning
about computer ethics cases and acquiring some skill and knowledge in
ethics issues.
The third level— theoretical—involves application of the theories of
philosophy, sociology, and psychology to computer science with the
hope that new understanding in the field can be achieved.
8. Are computer ethical issues new problems, or just a new twist
on old problems?
Response: Computer ethical issues are considered to be new problems
by those groups that feel that intellectual property is not the same as real
property. However, other groups feel that the same generic principles
should apply. No agreement between these two groups has been reached.
9. What are the computer ethical issues regarding privacy?

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 Response: People desire to be in full control of what and how much
information about themselves is available to others, and to whom it is
available. This is the issue of privacy.
The creation and maintenance of huge, shared databases make it
necessary to protect people from the potential misuse of data. This raises
the issue of ownership in the personal information industry. Should the
privacy of individuals be protected through policies and systems? What
information about oneself does the individual own? Should firms that
are unrelated to individuals buy and sell information about these
individuals without their permission?
10. What are the computer ethical issues regarding security?
Response: Computer security is an attempt to avoid such undesirable
events as a loss of confidentiality or data integrity.
Security systems attempt to prevent fraud and other misuse of computer
systems; they act to protect and further the legitimate interests of the
system’s constituencies. The ethical issues involving security arise from
the emergence of shared, computerized databases that have the potential
to cause irreparable harm to individuals by disseminating inaccurate
information to authorized users, such as through incorrect credit
reporting. There is a similar danger in disseminating accurate
information to persons unauthorized to receive it. However, increasing
security can actually cause other problems. For example, security can be
used both to protect personal property and to undermine freedom of
access to data, which may have an injurious effect on some individuals.

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 11. What are the computer ethical issues regarding ownership of
property?
Response: Laws designed to preserve real property rights have been
extended to cover what is referred to as intellectual property, that is,
software.
The question here becomes what can an individual (or organization)
own? Ideas? Media? Source code? Object code? A related question is
whether or not owners and users should be constrained in their use of or
access to software. This includes making copies or placing software on a
network to permit multiple access. Some believe that copyright laws can
cause more harm than good. For example, the League for Programming
Freedom argues that copyrights for software fly in the face of the
original intent of the law. It feels that the best interests of computer users
are served when industry standards emerge; copyright laws work to
disallow this. Part of the problem arises out of the uniqueness of
software, its ease of dissemination, and the possibility of exact
replication. Does software fit with the current categories and
conventions regarding ownership?
12. What are the computer ethical issues regarding equity in access?
Response: Some barriers to access (security systems) are intrinsic to
the technology of information systems, but some are avoidable
through careful system design.
Factors that can limit access to computing technology include: financial
cost, cultural barriers, and physical limitations (blindness, paralysis, and
pregnancy). How can hardware and software be designed with
consideration for differences in physical and cognitive skills? What is

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the cost involved with providing equity in access? To what groups of
society should equity in access become a priority?
13. What are the computer ethical issues regarding the
environment?
Response: Increased computing and the low cost of fast-speed
printers have caused many users to print out more hard copies of
documents than is really necessary.
Because paper is not usually considered a high-cost item, most firms
have not looked at this as a cost/benefit issue; however, perhaps they
should from an environmental viewpoint. Also, of growing importance
is the issue that disposal of obsolete computer hardware creates
environmental risks and concerns.
14. What are the computer ethical issues regarding artificial
intelligence?
Response: One issue is the responsibility for the completeness and
accuracy of a knowledge base, as well as its maintenance to reflect
changes.
Further, where does the knowledge come from? This issue becomes of
particular importance when expert systems replace the tasks of middle
managers, many of whom may have been used during the knowledge
acquisition phase. Thus, an important issue is who owns the coded
expertise. Also, what are the legal ramifications if an expert system
makes an error or if a decision made by an expert system is not
followed?

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15. What are the computer ethical issues regarding unemployment
and displacement?
Response: The nature of most jobs is changing as a result of computer
technology. In many cases, certain occupations are becoming rare. The
issue is whether employers should assume the responsibility of
retraining employees.
16. What are the computer ethical issues regarding misuse of
computers?
Response: The computer ethical issues regarding misuse of computers
are the copying of proprietary software, using a company’s computer for
personal benefit, and snooping through other people’s files.
Should employees be allowed to do personal work on the company
computer after work hours? Does this additional use impinge on the
rights of the software company? If the employee does not have to buy
hardware and/or software for him or herself, then an ethical issue arises
regarding potential lost profits to the industries selling these products.
17. What is the objective of Statement on Auditing Standards No.
99?
Response: The objective of SAS 99 is to seamlessly blend the auditor’s
consideration of fraud into all phases of the audit process. In addition,
SAS 99 requires the auditor to perform new steps such as a
brainstorming during audit planning to assess the potential risk of
material misstatement of the financial statements from fraud schemes.
18. What are the five conditions that constitute fraud under
common law?

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Response:
a. false representation
b. material fact
c. intent
d. justifiable reliance
e. injury or loss
19. Name the three fraud-motivating forces?
Response:
a. situational pressure. opportunities. ethics.
20. What is employee fraud?
Response:
Employee fraud is an act committed by nonmanagement employees. It
is generally designed to directly convert cash or other assets to the
employee’s personal benefit.
Employee fraud usually involves three
steps: (1) stealing something of value (an asset),
(2) converting the asset to a usable form (cash), and
(3) concealing the crime to avoid detection
21. What is management fraud?
Response: Management fraud is committed by managers who are not
subject to the same controls as employees.
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 This fraud more insidious than employee fraud because it often escapes
detection until the organization has suffered irreparable damage or loss.
Management fraud typically contains three special characteristics:
1. The fraud is perpetrated at levels of management above the one to
which internal control structures generally relate.
2. The fraud frequently involves using the financial statements to create
an illusion that an entity is healthier and more prosperous than, in fact, it
is.
3. If the fraud involves misappropriation of assets, it frequently is
shrouded in a maze of complex business transactions, often involving
related third parties.
22. What three forces constitute the triangle of fraud?
Response: a. situational pressures.
b. available opportunities.
C. ethics (personal characteristics).
23. How can external auditors attempt to uncover motivations for
committing fraud?
Response: Research by forensic experts and academics has shown that
the auditor’s evaluation of fraud is enhanced when the fraud triangle
factors are considered.
Obviously, matters of ethics and personal stress do not lend themselves
to easy observation and analysis. To provide insight into these factors,
auditors often use a red-flag checklist consisting of the following types
of questions:

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Do key executives have unusually high personal debt?
Do key executives appear to be living beyond their means?
Do key executives engage in habitual gambling?
Do key executives appear to abuse alcohol or drugs?
Do any of the key executives appear to lack personal codes of ethics?
Are economic conditions unfavorable within the company’s industry?
Does the company use several different banks, none of which sees the
company’s entire financial picture?
Do any key executives have close associations with suppliers?
Is the company experiencing a rapid turnover of key employees, either
through resignation or termination?
Do one or two individuals dominate the company?
24. What is lapping?
Response: Lapping involves a cash receipts clerk stealing customer
payments that are in the form of checks, by cashing the check him/
herself.
Many employees view this as borrowing, since they plan to repay it
some day. Lapping of accounts receivable works as follows: Period 1:
Cashier receives $1000 from ABC Company and keeps it. Period 2:
Cashier receives $1000 from XYZ Company and credits ABC
Company’s accounts receivable account. Period 3: Cashier receives
$1000 from JKL Company and credits XYZ Company’s accounts
receivable account. At any given time, accounts receivable is overstated
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by $1000, as well as cash. The employee keeps “lapping” the accounts,
so a customer will not receive a delinquent bill notice.

25. What is collusion?

Response: Collusion involves two or more employees working together
to perpetrate a fraudulent act that internal controls would have otherwise
prevented.
For example, the inventory control clerk and the warehouse clerk could
collude to steal inventory and then adjust the inventory records to cover-
up the act.

26. What is bribery?

Response: Bribery involves giving, offering, soliciting, or receiving
things of value to influence an official in the performance of his or her
lawful duties.
Officials may be employed by government (or regulatory) agencies or
by private organizations. Bribery defrauds the entity (business
organization or government agency) of the right to honest and loyal
services from those employed by it.

27. What is economic extortion?

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Response: Economic extortion is the use (or threat) of force (including
economic sanctions) by an individual or organization to obtain
something of value.
The item of value could be a financial or economic asset, information,
or cooperation to obtain a favorable decision on some matter under
review.

28. What is conflict of interest?

Response: A conflict of interest occurs when an employee acts on
behalf of a third party during the discharge of his or her duties or has
self-interest in the activity being performed.
When the employee’s conflict of interest is unknown to the employer
and results in financial loss, then fraud has occurred.
29. What is computer fraud, and what types of activities does it
include?
Response: Computer fraud refers to using hardware and software to
divert or acquire the assets of the firm.
Its activities include:
 Theft, misuse, or misappropriation of assets by altering computer-
readable records and files.
 Theft, misuse, or misappropriation of assets by altering the logic of
computer software.
 The theft of illegal use of computer-readable information,
 The theft, corruption, illegal copying, or intentional destruction of
computer software.
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  The theft, misuse, or misappropriation of computer hardware.

30. At which stage of the general accounting model is it easiest to

commit computer fraud?
Response: It is easiest to commit computer fraud at the data-collection
or data-entry stage. Frauds of this type require little or no computer
skills. At this point, the perpetrator only needs to understand how the
system works to enter data that it will process.

31. Define check tampering?

Response: Check tampering involves forging or changing in some
material way a check that the organization has written to a legitimate
payee.
32. What is billing (or vendor) fraud?
Response: Billing schemes, also known as vendor fraud, are perpetrated
by employees who cause their employer to issue a payment to a false
supplier or vendor. This is accomplished by submitting invoices for
fictitious goods or services, inflated invoices, or invoices for personal
purchases.

33. Define cash larceny?

Response: Cash larceny involves schemes in which cash receipts are
stolen from an organization after they have been recorded in the
organization’s books and records.
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34. What is skimming?
Response: Skimming involves stealing cash from an organization before
it is recorded on the organization’s books and records.

35- 40 I did not get it

Multiple choice
1. Management can expect various benefits to follow from implementing
a system of strong internal control. Which of the following benefits is
least likely to occur?
b. Prevention of employee collusion to commit fraud.

2.Which of the following situations is NOT a segregation of duties

violation?
a. The treasurer has the authority to sign checks but gives the signature
block to the assistant treasurer to run the check-signing machine.

3. The underlying assumption of reasonable assurance regarding

implementation of internal control means that
c. Implementation of the control procedure should not have a significant
adverse effect on efficiency or profitability.

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4. To conceal the theft of cash receipts from customers in payment of
their accounts, which of the following journal entries should the
bookkeeper make?
d. DR: Sales Return, CR: Accounts Receivable.
5. .Which of the following controls would best prevent the lapping of
accounts receivable?
a. Segregate duties so that the clerk responsible for recording in the
accounts receivable subsidiary ledger has no access to the general
ledger.

6. Providing timely information about transactions in sufficient detail to

permit proper classification and financial reporting is an example of
c. Information and Communication.

7. Ensuring that all material transactions processed by the information

system are valid and in accordance with management's objectives is an
example of
a. Transaction Authorization.

8. Which of the following is often called a compensating control?

b. Supervision
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9. which of the following is not an element of the fraud triangle ?
b. Justifiable
10. The fraud scheme that is similar to the borrowing from peter to pay
paul scheme is
C. lapping.

Revive question Revenue cycle

1. what document initiate the sales process ?

Response: A customer order usually in the form of a purchase order
initiates the sales process.
2. Distinguish among a packing slip, a shipping notice, and a bill of
lading?
Response:
• The packing slip travels with the goods to the customer,
• The shipping department sends the shipping notice to the billing
department
to notify it that the order has been filled and shipped
• The bill of lading is a formal contract between the seller and the
transportation carrier; it shows legal ownership and responsibility for
assets
in transit.
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3. what function does the receiving department serve in the revenue
cycle ?
Respose: The receiving department counts and inspects items that are
returned by customers. The receiving department prepares a return slip,
copies of which go to the warehouse for restocking, and to the sales
order department so that a credit memo can be issued to the customer.

4. The general ledger clerk receives summary data from which

departments? What form of summary data?
Response: The general ledger clerk receives a total of all sales from the
billing department in
the form of a summary journal voucher. The accounts receivable
department sends an account summary of the individual accounts
receivable so that the accounts receivable control account can be verified
against the accounts receivable ledger. The inventory control department
sends summary information in the form of a journal voucher that reflects
the total reductions of inventory in financial terms and the associated
charges to cost of goods sold.
5. What are three authorization controls?
Response:
a. credit checks
b. returns policy for granting cash refunds and credits.
c. cash prelists providing verification that customer checks and
remittance advices match in amount.
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6. What are the three rules that ensure that no single employee or
department
processes a transaction in its entirety?
Response:
a. Transaction authorization should be separate from transaction
processing
b. asset custody should be separate from asset record keeping
c. The organization structure should be such that the perpetration of a
fraud
requires collusion between 2 or more individuals

7. At which points in the revenue cycle are independent verification

controls necessary ?
Response:
a. Shipping department—verifies that the correct amount and types of
goods are sent from the warehouse by reconciling the stock release
document and the packing slip.
.b. Billing department—reconciles the shipping notice with the invoice
to ensure that customers are appropriately billed.
.c. GL clerks—reconcile journal vouchers from various
departments such as the billing department, the accounts
receivable department, and inventory control.
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8. What is automation, and why is it used?
Response: Automation involves using technology to improve the
efficiency and effectiveness of a task.
9. What is the objective of reengineering?
Response: Once an item is on order, control should be in place to ensure
that it is not ordered again until the original order has been received
from the supplier.
One method of accomplishing this is to “flag” the inventory item “on
order” by entering value (e.g., the number of items ordered) in the on-
order field of the inventory record. This field has a value of zero when
the item in question is not on order.
10. Distinguish among an edit run, sort run, and update run.
Response:

 An edit run is the first run; it detects most data entry errors.
 The sort run sequences the transaction records according to its
primary key
field and possibly a secondary key field.

 Once the data are sorted, the update program posts the transactions
to the
appropriate corresponding records in the master file.
During a sequential update, each record is copied from the original
master file to the new master file regardless of whether the balance is
affected.

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 11. What are the key features of a POS system?
A point of sale system immediately records both cash and
credit
transactions and inventory information. The sales journal, accounts
receivable,
and inventory accounts may be updated in real-time, or a transaction file
may be
used to later update a master file.
A point of sale system immediately records both cash and
credit
transactions and inventory information. The sales journal, accounts
receivable,
and inventory accounts may be updated in real-time, or a transaction file
may be
used to later update a master file.
Response: A point of sale system immediately records both
cash and credit transactions and inventory information. The sales
journal, accounts receivable, and inventory accounts may be updated in
real-time, or a transaction file may be used to later update a master file.
12. How is the primary key critical in preserving the audit trail?
Response: The primary key provides the link between the magnetic
records stored on a computer disk and the physical source documents
and business events that they represent.
13. What are the advantages of real-time processing?
Response: Multilevel security employs programmed techniques
that permit simultaneous access to a central system by many users with
different access privileges but prevents them from obtaining
information for which they lack authorization.
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14. Why does billing receive a copy of the sales order when the order
is approved but does not bill until the goods are shipped?
Response: The billing department’s receipt of the sales order occurs in
most instances before the goods are actually shipped; thus, the economic
event is not complete.
15. Why was EDI devised?
Response: EDI was devised to expedite routine transactions between
manufacturers and wholesalers, and between wholesalers and retailers.
An added benefit is the reduction of clerical errors.

16. What types of unique control problems are created by the use of
PC accounting systems?
Response: Instance, one employee may have the responsibility for
entering all transaction data, including sales orders, cash receipts,
invoices, and
disbursements.
17. In a manual system, after which event in the sales process should
the customer be billed?
Response: billing occurs after the product is shipped to the customer.
18. what is bill of lading?
Response: A bill of lading is form of contract between the seller and the
shipping company

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19. What document initiates the billing process? (carrier) to
transport goods to the customers?
Response: The billing process is initiated by the shipping notice, which
signals the shipment of the goods to the buyer.
20. where in the cash receipts process does supervision play an
important role?
Response: Supervision plays an important role in the mail room ,which
point of risk in most cash receipts systems.

Multiple choice

1. C
2. B
3. C
4. B
5. C
6. C
7. D
8. A
9. C
10. A
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 chapter 5 Expenditure cycle

1. Differentiate between a purchase requisition and a purchase

order?
A purchase requisition is completed by the inventory control department
when a need for inventory items is detected.
Purchase requisitions for office supplies and other materials may also be
completed by staff departments such as marketing, finance, accounting,
and personnel. The purchasing department receives the purchase
requisitions, and if necessary, determines the appropriate vendor. If
various departments have requisitioned the same item, the purchasing
department may consolidate all requests into one order so that any
quantity discounts and lower freight charges may be taken. In any case,
the purchasing department prepares the purchase order, which is sent to
the vendor, accounts payable department, and the receiving department
(blind copy).
2.What purpose does a purchasing department serve ?
Response: A purchasing department is able to research the quality and
pricing of various vendors. Their job is to monitor various supply
sources and choose the highest quality good for a given price that can be
reliably delivered on-time.
3. Distinguish between an accounts payable file and a vouchers
payable file?
Response: An open accounts payable file contains all source documents,
including invoices, organized by payment date.
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 As the due dates become close to the current date, the invoices are
pulled from the file and paid. Under the voucher system, the accounts
payable clerk prepares a cash disbursements voucher upon receipt of all
source documents. Each cash disbursements voucher represents payment
to one vendor. Multiple invoices may be covered by one voucher. The
voucher system thus allows fewer checks to be written and provides
better control over cash disbursements since cash vouchers are assigned
and tracked
4. What are three logical step of the cash disbursements system?
Response: The three logical steps of the cash disbursements system are:
a. authorization of cash disbursements for payment,
b. preparation and distribution of checks, and
c. preparation of summary information by cash disbursements and
accounts payable, which are sent to the general ledger clerk.
5. What general ledger journal entries does the pur- chases system
trigger?
Response:
accounts Payable :
Inventory Control Debit
Accounts Payable
Credit Cash
Disbursements:
Accounts Payable Debit
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 Cash Credit
6. What two types of exposures can close supervision of the receiving
department reduce ?
Response: The receiving clerk’s responsibility is to inspect the quantity
and condition of the
goods received. The two exposures that are reduced by close supervision
are:
1. failing to properly inspect the assets
2. pilfering or stealing the inventory
7. How can a manual purchases cash disbursements system be
reengineered to reduce discrepancies, be more accurate, and reduce
processing costs?
Response: A comparison of transaction details between the Purchase
Order (which established that the item was ordered), the Receiving
Report (which showed that it was received), and the Invoice (which
contains prices and other charges) is called a three-way match. Upon
reconciliation of these documents, a company typically will record the
liability.
8. What step of independent verification does the general ledger
department perform ?
Response: The general ledger department receives journal vouchers
from inventory control,
accounts payable, and cash disbursements. With these summary figures,
the
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general ledger clerk verifies that:
1. total obligations recorded = total recoded increases in inventories.
2. total reductions in accounts payable = total recorded disbursements of
cash
9. What is (are) the purpose(s) of maintaining a valid vendor file?
Response: Response Inventories should only be acquired from valid
vendors. This control procedure helps to deter the purchasing agent from
buying inventories at excessive costs and receiving kickbacks, or from
buying from an entity in which the purchasing agent has a relationship,
such as a relative or a friend. A valid vendor file also provides for a
more efficient purchasing process when dealing with routine purchases.
10. How do computerized purchasing system help to reduce the risk
of Purchasing bottlenecks ?
Response: Many companies engaged in business-to-business (B2B)
transactions use the vendor invoice file as a substitute for the traditional
purchases journal and accounts payable subsidiary ledger. The invoices
in the file provide a chronological record of total purchases for the
period (equivalent to the purchases journal), and the unpaid invoices at
any point in time constitute the organization’s accounts
11. What is the purpose of the blind copy of a pur- chase order?
Response: The blind copy contains no quantity or price information
about the products being received. The purpose of the blind copy is to
force the receiving clerk to count and inspect inventories to complete the
receiving report.
12. Give one advantage of using a vouchers payable system ?
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Response: Vouchers provide improved control over cash disbursement,
and they allow firms
to consolidate several payments to the same supplier on a single
voucher, thus
reducing the number of checks written.

Multiple choice

b .1
a .2
c .3
b .4
d .5
c .6
d .7
d .8
c .9
c .10

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