Solution Manual for Detecting Accounting Fraud: Analysis and Ethics Global Edition, 1st Edition

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Chapter 1: Introduction to the Problem of Accounting Fraud1Chapter 1Introduction to the Problem of Accounting FraudSOLUTIONSTrue/False Questions:1.False2.False3.False (The Sarbanes-Oxley Act was passed in 2002.)4.True5.False6.False7.True8.False (The Dodd-Frank Act revised and increased the power ofthe SEC.)9.True10.TrueFill-in-the-Blank Questions:11.Section 40412.audit13.banking14.high-quality15.201016.corporate fraud17.Public Oversight Board18.Volcker19.familiarity20.toxicor risky

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DETECTING ACCOUNTING FRAUD2Multiple-Choice Questions:21.cExplanation:The SEC is a government regulatory bodyandwas not complicit in the fraud,nor was its role examined or faulted by the Bankruptcy Examiner.•Answers a, b, and d are incorrect becauseThornburgh foundgatekeepingfailures inWorldCom‘sinternalaudit structureandwith itsexternalauditorsand itsboardofdirectors.22.bExplanation:In manycases, senior management compensation agreements included stockoptions that would provide significant additional remuneration if analysts’ earningsexpectations were met.•Answers a, c, and dare incorrect because theywere notcited ascommon reasons toorchestrate frauds.23.bExplanation:•Answers a, c, and dare true statements.24.aExplanation:•Answersb, c, and d are incorrect because Section 301 of SOX mandated theestablishment of hotlines for anonymous whistleblowers in the U.S. butended up causingproblems for some American companies with European subsidiaries because very fewcountries in Europe have laws that protect whistleblowers.25.aExplanation:The major objectives of Dodd-Frank are to “reshape the U.S. regulatory systemin a number of areas including but not limited to consumer protection, trading restrictions,credit ratings, regulation of financial products, corporate governance and disclosure, andtransparency” (“The Laws” 2012).•Answer a iscorrect becauseDodd-Frank does not attempt to increase the number of auditfirms.

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Chapter 1: Introduction to the Problem of Accounting Fraud326.dExplanation:All of thechangesmentioned, plus others, have resulted from Dodd-Frank.27.aExplanation:ThroughDodd-Frank’s whistleblower program,whistleblowersareofferedmoreprotection than under Sarbanes-Oxley, andthey can now receive monetary awards fromthe SEC which is pursuing whistleblower tips very seriously.•Answers b, c, and d are incorrect because whistleblowers are taken seriously by the SECand they can receive monetary awards.28. aExplanation:The director who works for a competing company,Raining Raisins, may havea conflict of interests.•Theemployment status of the other directors would be unlikely to result in conflicts ofinterest.29.aExplanation:•Answers b, c, and d are incorrect because some of the most outrageous corporate lootingprior to SOX occurred via the two-step loan process, as mentioned in statement a.30.dExplanation:•Answers a, b, and c are true statements.

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Chapter 2: Ethics at Work11Chapter 2Ethics at WorkSOLUTIONSTrue/False Questions:1.True2.False3.FalseExplanation:Business ethics is a type of applied ethics. Metaethics is concerned with whatconstitutesthe good and the bad, while business ethics deals with the ethics of particularsituationsandwithina particular discipline.4.FalseExplanation:This is one of the limits ofconsequentialism. Although it judges an action bythe consequences, it is unable to predict every possibleconsequence.5.True6.TrueExplanation:This is the hallmark ofdeontology.7.FalseExplanation:This is the goal of virtueethics.8.False9.True10.TrueExplanation: A specific transaction can cause a specific person to have the right to have aloan repaid.Fill-in-the-Blank Questions:11.truthful12.maximize13.allocated14.need

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DETECTINGACCOUNTING FRAUD2215.character16.Aristotle17.utilitarianism18.hedonism19.same20.facts, stakeholdersMultiple-Choice Questions:21.cExplanation: Answers a and b are true statements.22.bExplanation:According to Kant’s categorical imperative, the end does not justify the means.•Answers a, b, and c are allconsistent with Kant’s categorical imperative.If Kant thoughtthe end justified the means, he would have been a consequentialist.23.cExplanation:According to the virtue theory of ethical behavior, the most important aspect ofmorality is found within an individual’s character.•Answer a is incorrect because deontology emphasizes duty•Answer b is incorrect be utilitarianism emphasizesconsequences24.dExplanation:Answers a, b,and care true statements.25.aExplanation: Anne would beusingsome ofthe consequences of herpossibleresponse toguide her behavior.26.bExplanation: She would be using her sense of duty (in this case telling thetruth)to guide herbehavior.Duty is the guiding principle of deontology.27. aExplanation: Thistype of thinkingisconsidereda shortcoming ofconsequentialism. Attimes, it can permit egregious acts in the name of the greater good.

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Chapter 2: Ethics at Work3328.aExplanation:Anotherlimit ofconsequentialismisthatthescopeof the consequences isoftenunclear.29.bExplanation: Autonomyisnot acardinal virtue.•The cardinal virtues are: courage,temperance, wisdom,and justice.30.cExplanation:Self-defense rights were not identified by Sterba•Sterba identified action rights,in personarights,in remrights, and recipient rights.For Discussion:31.Reponses will vary. Here are some possible reactions:Possible VirtuePossibleDescriptionHonestyPreparingfinancialstatements that fairlyrepresent the entity’s financial position and theresults of its operationsDiligenceWorking hard and with accuracyto get a jobdone; finishing a task one is givenCourageSpeaking out against unethical businesspractices; refusing to prepare fraudulentfinancial statements.WisdomKnowing when to speak outFairnessNot having favorites; keeping all users offinancial statements in mindGenerositySpending time on mentoringless experiencedaccountants.Considering the cultivation of virtues, sincevirtue ethics is about the virtuous person, oftenvirtue ethics is taught by example and/or through narrative. A way to teach business virtuesmight be through a story about a virtuous accountant. Students may elect to write a tale about avirtuous accountant that teaches lessons about how a virtuous person may respond to difficultethical business dilemmas.

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DETECTINGACCOUNTING FRAUD44Aristotle thought virtues were cultivated through habit. In this view, small and regularbehaviors shape character. To cultivate the virtue of generosity, for example, one might start ona small-scale by giving a dollar to a homeless person on the street, bringing brownies to give outat work, or being generous with one’s time by genuinely asking and listening to how a co-workeris doing. Also in this view, one does not magically become a courageous whistle-blower, forexample, but rather the virtue of courage is fostered through day-to-day courageous acts, such asspeaking out against gossip, admitting when one makes a mistake, and offering one’ssuggestions at a work meeting.32.Reponses will vary. Here are some possible reactions:Those who assert that virtues in business are related to virtues in personal life may supporttheir answerswith some of the following beliefs: virtues exist in unity; virtues are developedthrough habit;a person’s life cannot be compartmentalized, but must be treated as anintegrated whole. If someone believes virtues are developed through habit, as Aristotlethought, that person is likely to assume that vices in one’s personal life will lead to vices inone’s business practice. For example, if a husband lies to his wife, he will becomehabituated to lying, making it easier to lie on balance sheets.Conversely, the husband who isa good communicator and who is always honest with his wife is more likely to communicatewell and value honesty in the workplace.Others may regard one’s personal life as distinct from one’s professional life. Thisgroup may believe that personal and professional lives have an impermeable barrier and/orare governed by entirely different, and thus unrelated, virtues. For instance, one may believethat intimate relationships require a totally different set of virtues than business relationships,and thus these are unrelated. And/or one may not think virtues are acquired throughhabitand so lying to one’s spousedoes not make it easier or more likely that one will lie onbalance sheets.Some may think that the virtues exist in unity because they belong to one agent. Inthis view, it is unlikely that one is very honest and at the same time lacks courage. Forexample, one could not be very honest without courage because courage is necessary to tell

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Chapter 2: Ethics at Work55the truth in difficult situations. Also, being honest can help to foster courage as acommitment to honesty inspires courage.Others may think it is entirely possible to possess some virtues and some vicesbecause they regard the virtues as unrelated. This group may choose seemingly disparatevirtues to make this case. For example, a person who is honest, but not just, such as amanager who is very honest about hisor herbiases against certain employees.33.Reponses will vary. Here are some possible reactions:Some may think intention matters in so far as a right action is not truly right unless it ismotivated by good intentions.Othersmay think intention matters insofar as awrong action ispermissible if it is for the right reasons. This logic follows thesaying, “The end justifies themeans.”Some may think intention is important, but that it does not determine if an action isright or wrong.A strict consequentialist may believe that only consequences count, so even if one’sintentions are coming from a good place, it is only the outcome that matters. For example,someone wants to improve the business of a group of farmers and gives them a popular grainseed that unintentionally wipes out all their crops. Although the person meantwell, theconsequentialist mayassert that the consequences indicate that the person acted wrongly.(Issues of intent also bring up notions of culpability, which are beyond the scope of thischapter. However, it is important to note that there is a distinction between causalculpability—causing the destruction of crops, in this case—and moral culpability, i.e.theextent to which one is morallyresponsiblefor the destruction of the crops.)To the strict deontologist,an action performed out of a sense of duty has more moralvalue than the same action taken because of its likely consequences in that specific situation.Virtue ethics is most able to take into account intent because it is concerned with thecharacter of thewhole person and with all of that person’s character traits.34.Reponses will vary. Here are some possible reactions:The best answer will first define happiness. One definition ofhappiness is that it is atypeof persistent, peaceful joy (as opposed to an ecstatic, manic, euphoric, and fleeting

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DETECTINGACCOUNTING FRAUD66feeling).This background joy remains constant during temporary disappointments anddifficulties.For some, acting ethically is accompanied by happiness even when acting ethically ishard. For example, standing up for a co-worker who is being picked on may not make onepopular at work and it may not be easy, but it may also be accompanied by a senseof calmand satisfactionknowing that one actedethically.Wrong actions may be accompanied bygreat anxiety, such as when one is involved in a weboflies or when one cheats on a test.Others will thinkthat the costs of right action may betoogreat. For example, it doesnot feel good to become apariah at work for standing up for a co-worker who ispicked on.It is possible that some maythink that they would feel happier if theycheatedon a test ratherthanfailed a class and hadto repeat it.35(a).Reponses will vary. Here are somepossible reactions:For some, this example is the quintessential reason why duty ethics are vital. Here, themanager’s sense of duty overrides hernegative feelings for the employee, enabling theemployee to receive the deserved promotion based on timely and accurate work over thelast two years. Thus, this example illustrates why duty and reason are crucial to businesspractice.Others will feel slighted that the promotion is not inspired by the manager’sopinion that the employee is a likeable and congenialworker. These people may want tobe promoted because the bosshas a positive attitude towards them, and not because theboss is following protocol,rules, and duty.35(b).Reponses will vary. Here are some possible reactions:For some, the managing partner’s ability to offer a promotion in spite of her biasedfeelings will show great integrity and fairness. Lettingreason and not emotions guide herdecisions will be looked upon by some as very ethical.Others will not be impressed that the boss gave the promotiononlybecauseshefelt duty-bound to do so. They will think that her lack of authentic and genuineenthusiasm for the employee underminesthe morality behindher actions. These people

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Chapter 2: Ethics at Work77may think that abiding by rules andduties arenot enough to make someone an ethicalperson and that the boss should feel the genuine desire to give the promotion.36.Reponses will vary.Some things toconsider includepay discrepancies between men and women;promotions for men and women; the presence of a ‘glass ceiling’ for women;howmaternityleave is treated for fathers and mothers in theworkplace;andsocial expectations of men andwomen in the workplace. For instance,are womenand mensometimes held to differentstandards of dressin the business world?Are they held to different standards of behavior?Isthere a difference between how co-workers perceivealong response from a woman versusalong response from a man? If there is a difference, which attitude is rewarded? Is there adifference or a perceived difference in the way women and men approach takingrisks inbusiness?If thereis a difference, which approachis rewarded?Is there a difference or aperceived difference in the waywomen and men promote themselves? If thereis a difference,which approachis rewarded? Is there a difference or a perceived difference between male andfemale styles ofmanagement? If so, which style ismost likely to berewardedor respected?CASE STUDY:Peter Madoff, Brother of Bernard Madoff and Former Chief ComplianceOfficer and Senior Managing Directorof Bernard L. Madoff InvestmentSecurities, LLCa (i).StakeholderConsequenceSourcePeter MadoffTemporary gain ofwealth, luxuriouslifestyle, prestige;Followed bylong-term money loss,imprisonment,embarrassment,separation fromU.S. AttorneyPreet Bharara said, “Hewill now be jailed well into old age,and he will forfeit virtually everypenny he has.”

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DETECTINGACCOUNTING FRAUD88family, despised byclients & formerfriendsLaw abiding taxpayersPaid taxes whenMadoff did notIRS-CI Acting Special Agent inChargeToni Weirauchsaid, “One ofthe consequences of the concealmentis that the IRS was hindered fromperforming its lawful duty, thusharming our nation’s law abidingtaxpayers, along with the defraudedvictims.”Special Agent Robert L. Panella said,“During today’s plea, Peter Madoffadmitted to his role in a fraud schemethat harmed the savings of thousandsof investors.”IRSIRS was hinderedfrom performing itslawful duty; publicmoney was lostThousands of investorswho were defraudedLost money,sometimes lost mostof their retirementsavings & had toreturn to work;fooled, cheated, liedtoEmployeesEconomic securitylost, benefits lost,Inability to supportfamilySpecial Agent Robert L. Panella saidthat Madoff “undermine[d] thefinancial well-being of workers.”Madoff also “Failed to protect theintegrity of employee benefit planassets….”RegulatorsWere all tricked intobelievingfalsehoods; wereunable to performtheir jobsappropriately“Madoff created numerousfalsecompliance documents in which hestated that he had performedcompliance reviews of the trading inthe BLMIS IA business on a regularbasis, when, in reality, the reviewswere never performed. The falsestatements were designed to misleadregulators, auditors, and IA clients”AuditorsWere all tricked intobelievingfalsehoods; wereunable to performSee above quote.“The numerous false statements in theForms ADV created the falseIA [Investment Advisory]clients

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Chapter 2: Ethics at Work99a (ii).Based on the consequencesdiscussed above, it seems as if allstakeholderssufferednegative consequences. The positive consequences for Madoff and his family wereenjoyed in the short-term only. Based on the utilitarian notion to choose the action thatgives the greatest good to the greatest number, Madoff should not have committed hiscrimes.a (iii).Egoism is a type of consequentialism that judges actions by the benefitsforonlyoneself.According to the article, Madoff was only concerned about himselfand his favorites:“DOL-EBSA New York Regional DirectorJonathan Kay said, ‘Today’s plea is atestament to the good work and strong collaboration among multiple federal agencies.This agency remains committed to protecting worker benefit plans from those who woulddefraud them forpersonalgain.’”Special Agent Panella said that Peter Madoff“personally benefited from proceeds gained as a result of these false statements.”ManyBernard L. MadoffInvestment Securities(BLMIS) clientstheir jobsappropriatelyThought they wereinvesting in an elite,thriving companyappearance that BLMIS’s IA businesshad a small number of highlysophisticated clients and far fewerassets under management than wasactually the case.”His wife MarionShort-term gain ofmoney;long-term loss ofmoney and life-style, separationfrom father/husband,severeembarrassment“The government has entered into asettlement with Madoff’s family thatrequires the forfeiture of all of his wifeMarion’s and daughter Shana’s assetsand assets belonging to other familymembers.”Daughter ShanaShort-term gain ofmoney;long-term loss ofmoney and life-style, separationfrom father/husband,severeembarrassmentSee above quote.

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DETECTINGACCOUNTING FRAUD1010people suffered for Madoff’s narcissistic actions: “Manhattan U.S. Attorney PreetBharara said, ‘Peter Madoff enabled the largest fraud in human history….We are not yetfinished calling to account everyone responsible for the epic fraud of Bernard Madoff andthe epic pain of his many victims.’” IfPeterMadoff had considered the consequences forpeopleother than himself, hemay have acted differently.b (i).Responses shouldtake the following into account:DutyHow MadoffFell Shortof His DutyFulfill his commitment toconduct reviews“He certified that periodic reviews established thefirm’s compliance with internal andregulatory rules.In fact, Peter Madoff conducted no reviews. Hecertified that his examination of the firm’s tradingprocess established its integrity. He did not—indeed,he could not—conduct any such examination:”“He made a pretense of compliance; he was reallyabout complicity.” (Janice K. Fedarcyk)Honesty•“Madoff created false and misleading BLMIScompliance documents.”•“False reports that were filed with the U.S.Securities and Exchange Commission (SEC)….”•“The numerous false statements in theForms ADVcreated the false appearance that BLMIS’s IAbusiness….”Civic responsibilityEvading taxes:•PeterMadoff received approximately $15,700,000from Bernard L. Madoff and his wife and executedsham promissory notes to make it appear that thetransfers were loans, in order to avoid payingtaxes;•Madoff gave approximately $9,900,000 to familymembers, and in order to avoid paying taxes,executed sham promissory notes to make it appearthat the transfers of these funds were loans;•Madoff did not pay taxes on approximately

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Chapter 2: Ethics at Work1111$7,750,000 that he received from BLMIS;•Madoff received approximately $16,800,000 fromBernard L. Madoff from two sham trades, anddisguised the proceeds of the trades as long-termstock transactions in order to take advantage of thelower tax rate for long-term capital gains;•Madoff charged approximately $175,000 inpersonal expenses to a corporate American Expresscard and did not report those expenses as income.Madoff also arranged for his wife to have a “no-show” job at BLMIS from which she receivedbetween approximately $100,000 to $160,000 peryear in salary, a 401(k), and other benefits towhich she was not entitled.Fairness“Madoff agreed with others to send the $300 millionthat remained in the IA accounts topreferredemployees, family members, and friends”Duty totake care of hisemployeesRobert L. Panella saidthatMadoff,“Failed to protectthe integrity of employee benefit plan assets andpersonallybenefited from proceeds gained as a resultof these false statements.”b (ii).Responsesmay vary. Some students may argue that reason and duty were not sufficientto prevent Madoff from unethical behavior and thatcompanies need more oversightand/or there should be stricter laws governing accounting practices and/or we need bettercompliance ofthe lawsalready in place.Others may maintain that Madoff lacked amoral compass and a character strong enough to withstand the temptationto enrichhimself. Others may argue that he did not consider the consequences of his actions.c (i).Responseswill vary, but should include that consequentialism accounts for the far-reaching repercussions ofMadoff’sspecificactions and deontology does not.Consequentialismidentifies all of the stakeholders affected by Madoff’s fraud as well asthe far-reaching consequences. On the other hand, deontology focuses on the unwavering

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DETECTINGACCOUNTING FRAUD1212commitment to principle and duty, in this case, for example, the moral imperative to behonest at all times.c (ii).Some students may find consequentialism more persuasive for the reason thatit forcesone to considerthe far-reaching consequences toall the stakeholders.Some may thinkthe consequences are the most egregious parts of the act, while others will think skirtingobligations are the worst parts of the crime.They may believe that a commitment to themoral imperative to always tell the truth would best prevent this kind of offense.c (iii).Somestudentswill think one system is best for all cases, while others will think eachissue needs its own system.There are also those who may believe that when faced withan ethical dilemma, one should analyze it in terms of all three frameworks.d.Responsesmay vary, but should include the following:(Answersare in bold)Using theAmerican Accounting Association Ethical Decision-Making Model:1.Determine the facts—who,what, when, where,and how?What do we know or need to know, if possible, that will help define the problems?Who? A chief compliance officerworking for MadoffWhat?Securities fraud, tax fraud conspiracy, falsifying books and records, andmaking false statements to investorsWhen?1996-2008Where? Bernard L. Madoff Investment Securities (BLMIS),New York, NY.How?“Madoffcreated false and misleading BLMIS compliance documents, aswellas false reports that were filed with the U.S. Securities and ExchangeCommission (SEC) that materially misstated the nature and scope of BLMIS’sInvestment Advisory (IA) business.”2.Define the ethical issue.a)List the significant stakeholdersSeeanswerto Case StudyQuestion a(i) aboveb)Define the ethical issuesMake sure precisely what the ethical issue is; for example:conflicts involving rights,questions over limits of an obligation, etc.

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