Question 3 10 Marks

1. Which of the following are symptoms of understatement of liabilities (liability fraud)?

(5 marks)

Potential symptom	Y/N?
Purchases discounts appear too high
Too little cash paid relative to recorded purchases
Unusual entries made at the end of the accounting period that reduce expenses
Decreases in Accounts Payable seem too high
Warranty allowance appears too high
Increase in purchases returns
New, unusual vendors appear not to have gone through the approval process

2. An easy way to commit financial statement fraud is to overstate ending inventory. Complete the following 2 tables. Why does this type of fraud tend to put a lot of pressure on the company in the following year?

(5 marks)

What is the effect of overstating ending inventory on cost of sales? (2 marks)

	Period 1 overstated inventory	Period 2
Beginning inventory	None
+ Purchases
- Purchases returns
- Purchases discounts
Goods available for sales
- Ending inventory	Overstated
Cost of sales

Question 3 continued next page

Question 3 (continued)

What is the effect of overstating ending inventory on the income statement? (2 marks)

Income Statement	Effect of overstating inventory?
Sales
- Sales returns
- Sales discounts
Net sales
- Cost of sales
Gross margin
- Expenses
Profit

Why is there pressure in the second year? (1 mark)