Forensic Accounting

By Mary-Jo Kranacher, CPA/CFF, CFEChapter 6

Legal, Regulatory, and Professional Environment

LEARNING OBJECTIVES6-1 Compare and contrast the remedies available in the civil and criminal justice systems.6-2 Identify the circumstances that require a Miranda warning.6-3 Explain what constitutes ‘‘good cause’’ in the discharge of an employee.6-4 Discuss the different approaches used by investigators to obtain documents.6-5 Describe what is meant by demonstrative evidence and give examples.6-6 Discuss the difference between probation and parole.6-7 Describe the factors that affect the decision to prosecute an entity.6-8 Explain the discovery process.6-9 Differentiate between the three major types of negotiated remedies.6-10 Discuss the primary purpose of the Sarbanes–Oxley Act of 2002.

True/False6-T/F #1. Fraud may only be prosecuted criminally.Answer: False

6-T/F #2. If the victims or others with a stake in the outcome of a fraud trial are not satisfied with the results of the criminal justice system, they may pursue their claim through the civil justice system.

Answer: True

6-T/F #3. In addition to the criminal and civil justice systems, regulatory agencies also play an important role in monitoring illegal activities and pursuing those responsible.

Answer: True

6-T/F #4. The First Amendment provides that a person cannot be compelled to provide incriminating information against himself in a criminal case.

Answer: False

6-T/F #5. The Fourth Amendment prohibits unreasonable searches and seizures.Answer: True

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6-T/F #6. The Twentieth Amendment entitles a person to due process of law and equal protections under the Law.

Answer: False

6-T/F #7. Because employers do not have the right to place employees in a custodial setting, an employee has limited Fifth Amendment rights.

Answer: True

6-T/F #8. As long as a nonpublic entity is conducting the interview, an employee does not have the right to have a lawyer present during the interview.

Answer: False

6-T/F #9. Anyone in a public park, parking lot, or mall may be videotaped without violating any laws as long as no audio of the target is recorded.

Answer: True

6-T/F #10. Probable cause is the standard by which law enforcement may make an arrest, conduct a personal or property search, or obtain a warrant.

Answer: True

6-T/F #11. Generally, evidence is admissible in court if it is relevant, its probative value outweighs any prejudicial effects, and it is trustworthy.

Answer: True

6-T/F #12. In the criminal justice system, individuals can be named as defendants, but businesses and other organizations may not be prosecuted.

Answer: False

6-T/F #13. Subsequent to the passage of the Sarbanes–Oxley Act of 2002, the auditing of public companies became the responsibility of the newly created American Institute of CPAs (AICPA).

Answer: False

6-T/F #14. The Sarbanes–Oxley Act of 2002 was signed into law on July 30, 2002 to address corporate governance and accountability as well as public accounting responsibilities in improving the quality, reliability, integrity, and transparency of financial reports.

Answer: True

6-T/F #15. The PCAOB is charged with overseeing public company audits, setting audit standards, and investigating acts of noncompliance by auditors or audit firms.

Answer: True

6-T/F #16. Section 404 of SOX recommends, but does not require, the company’s external auditors to attest to and issue a report on management’s assessment of internal control.

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Answer: False

6-T/F #17. SOX also makes it unlawful for any officer or director of a public company to take any action to fraudulently influence, coerce, manipulate, or mislead an auditor in the performance of an audit of the company’s financial statements.

Answer: True

6-T/F #18. The Sarbanes–Oxley Act mandates that each member of a company’s audit committee must be a member of its board of directors and must otherwise be independent.

Answer: True

Multiple Choice6-M/C #1. The ________ Amendment prohibits unreasonable searches and seizures.

A. FifthB. FourthC. SixthD. Fourteenth

Answer: B

6-M/C #2. The ______ Amendment provides that a person cannot be compelled to provide incriminating information against himself or herself in a criminal case.A. FifthB. FourthC. SixthD. Fourteenth

Answer: A

6-M/C #3. The ______ Amendment provides that an individual has the right to an attorney to defend himself and the right to confront witnesses against him.A. FifthB. FourthC. SixthD. Fourteenth

Answer: C

6-M/C #4. The ________ Amendment entitles a person to due process of law and equal protections under the Law.A. FifthB. FourthC. SixthD. Fourteenth

Answer: D

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6-M/C #5. The Miranda warnings consist of everything but the following:A. The interviewee has a right to remain silent.B. The interviewee has a right to an attorney.C. The interviewee’s answers may NOT be used against him.D. If the interviewee cannot afford an attorney, one will be provided at no

cost.Answer: C

6-M/C #6. It is advisable that employers document good cause for any termination in the employee’s personnel file. Good cause might include the following EXCEPT:A. The employee’s conduct was against written policy.B. The investigation was fair, objective, and evidence suggested the

elimination of alternative suspects.C. The punishment fits the crime, meaning that the punishment is reasonable

given the nature of the offense.D. The termination was discriminatory, meaning that not all persons

committing such an act were or would be terminated.Answer: D

6-M/C #7. Legal privileges are protections against certain types of testimony. Which of the following is not a legal privilege?A. Attorney–client privilegeB. Librarian-patron privilegeC. Attorney work-product privilegeD. Physician–patient privilege

Answer: B

6-M/C #8. Generally, investigators can obtain documentary evidence using all approaches EXCEPT:A. theft.B. voluntary consent.C. subpoena.D. search warrant.

Answer: A

6-M/C #9. Targets may enter the criminal justice system from all of the routes below except for:A. a warrantless arrest by the police based upon probable cause.B. a grand jury proceeding that leads to an indictment and a subsequent arrest

warrant issued by a judge.C. an investigation that leads to the filing of an Information.A. a citizen’s arrest.

Answer: D

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6-M/C #10. The normal order of discovery includes the following steps in what sequence? 1. Interrogatories 2. Attorneys take depositions3. Request to produce documents4. Requests for admission

A. 1, 3, 2, 4B. 2, 1, 4, 3C. 4, 3, 2, 1D. 1, 2, 3, 4

Answer: B

6-M/C #11. Which of the following is not a major form of negotiated settlements in a civil trial?A. out-of-court settlementsB. majority jury voteC. arbitrationD. mediation

Answer: B

6-M/C #12. The basic accounting flow consists of the following events in what sequence?1. Post to general ledger2. Business transactions occur3. Financial statements are prepared4. Journal entries are recorded

A. 2, 4, 1, 3B. 2, 4, 3, 1C. 4, 2, 3, 1D. 4, 3, 1, 2

Answer: A

6-M/C #13. Which of the following statements is not a major financial statement?A. Income StatementB. Balance SheetC. Statement of Cash FlowsD. Sales Budget

Answer: D

6-M/C #14. The purview of auditing of nonpublic companies falls under the guidelines of the:A. FASBB. PCAOBC. AICPAD. GAO

Answer: C

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6-M/C #15. The AICPA has the authority to set standards and make rules in all the following areas EXCEPT:A. Auditing standards (for nonpublic companies).B. Auditing standards (for public companies).C. Code of professional conduct.D. Compilation and review standards.

Answer: B

6-M/C #16. Which of the following is not a major provision in the Sarbanes-Oxley Act of 2002?A. Creating an independent regulatory framework for the accounting

profession.B. Enhancing the quality and transparency of financial reports.C. Revising the process of establishing new financial accounting standards.D. Establishing new protections for corporate whistleblowers.

Answer: C

6-M/C #17. Which of the following is not a responsibility of the PCAOB?A. Registering public accounting firms that audit publicly traded companies.B. Inspecting registered public accounting firms.C. Converging GAAP standards with IFRS standards.D. Enforcing compliance with the Sarbanes–Oxley Act.

Answer: C

6-M/C #18. In September 2004, the Committee of Sponsoring Organizations (COSO) of the Treadway Commission released their _______ framework, recognized by the SEC as the critical methodology for Sarbanes–Oxley.A. ERMB. IFRSC. XBRLD. XML

Answer: A

6-M/C #19. PCAOB Auditing Standard No. 3 (AS3), Audit Documentation, requires that audit engagement documentation should include a list of all EXCEPT:A. significant fraud risk factors.B. the auditor’s response.C. the results of the auditor’s related procedures.A. List of the internal controls.

Answer: D

6-M/C #20. Members of the PCAOB are appointed by the:A. AICPAB. SECC. FASBD. IASB

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Answer: B

6-M/C #21. The lead audit or coordinating partner and reviewing partner of the registered accounting firm must rotate off of the audit every ________ years.A. FiveB. TenC. TwoD. When the PCAOB mandates it.

Answer: A

Short Answer Essay 6-SAE #1. What common law protections do individuals have during interviews? Answer: These include:

Minimization of invasion of the employee’s privacy Limitations on interview content to employee job duties and responsibilities Limitations on public disclosure of the employee’s private facts Limitations on intentional infliction of emotional distress on the employee Limitations on defamation - unfounded facts and accusations made by the

interviewer A duty to deal fairly and in good faith No false imprisonment

6-SAE #2. Discuss the considerations that must be given in respect to documentary evidence.Answer: Five considerations must be given to any piece of documentary evidence:

1. The document must not have been forged.2. Original documents are preferable.3. The document must not be hearsay or objectionable.4. The document needs to be authenticated.5. The document must be reliable.

Critical Thinking ExerciseA scientist has two buckets, one holds four gallons and the other holds five gallons. In addition, the scientist also has an unlimited water supply. By using nothing but the buckets and water, how can the scientist accurately measure three gallons of water?Answer: First you dump out the 4 gallon jug. Second you dump some of the 5 gallon jug's

water into the 4 gallon jug so the 4 gallon jug is completely full. Dump out the 4 gallons. Now you have 1 gallon of water held in the 5 gallon jug. Pour the 1 gallon into the 4 gallon jug. Fill up the 5 gallon jug and pour some of the water of the 5 gallons into the 4 gallon container. Now dump out the 4 gallon jug. You now have 3 gallons held in the 5 gallon jug!

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Text Review Questions 6-TRQ #1. What remedies are available through the civil and criminal justice systems?Answer: There are three major forms of negotiated remedies in civil procedures: out-of-

court settlements, arbitration, and mediation. The criminal justice system may result in fines, community service, probation, incarceration, censure, and even capital punishment. In the United States, however, there are no fraud crimes that carry the death penalty.

6-TRQ #2. Under what circumstances would a Miranda warning be required?Answer: In custodial settings by law enforcement, and in those settings where the

suspected perpetrator has been taken into custody and denied freedom presumably against their will, federal law may require that a Miranda warning be read to the suspect.

6-TRQ #3. What constitutes “good cause” in the discharge of an employee?Answer: Good cause might include the following:

• The employee’s conduct was against written policy.• The employee’s conduct made for unsafe or inefficient business operations.• The company completed a reasonable investigation to ensure that any such

questionable act was committed by the employee and has evidence to support such a claim.

• The investigation was fair, objective, and evidence suggested the elimination of alternative suspects.

• The termination was nondiscriminatory, meaning that all persons committing such an act were or would be terminated.

• The punishment fits the crime, meaning that the punishment is reasonable given the nature of the offense.

6-TRQ #4. What approaches are used by investigators to obtain documents?Answer: Generally, investigators can obtain documents using three approaches:

• Voluntary consent• Subpoena• Search warrant

6-TRQ #5. What is meant by demonstrative evidence? Give examples.Answer: Demonstrative evidence is any evidence that purports to educate, summarize, or

amplify real evidence.

PowerPoint slides, summary schedules, graphics, pictures, reenactments, models, etc. are all forms of demonstrative evidence. Demonstrative evidence tends to tell a story and complements other forms of evidence such as real and testimonial evidence. Some examples of demonstrative evidence include the following:• Photographs and videotapes.• Maps, charts, diagrams, drawings.• Scale models.• Computer reconstructions or animations.

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• Scientific tests or experiments.

6-TRQ #6. In the criminal justice system, how is probation different from parole?Answer: Probation is a penalty and is used as an alternative to prison, whereas parole is

used to describe the corrections process subsequent to having served time in prison. Parole is often used as a reward for good behavior during time served. During the parole period, a parole officer is assigned.

6-TRQ #7. What are the factors that affect the decision to prosecute an entity?Answer: Generally, businesses may be held liable, assuming that the scope of the infraction

was within the duties of the individual who committed the crime, and the individual was acting as an agent for the entity. In addition, the agent’s action was intended to benefit the entity. Factors that affect the decision to prosecute an entity are similar to those for individual prosecution and include the sufficiency of evidence, likelihood of success at trial, probability of deterrence and rehabilitation, and adequacy of nonprosecutorial remediation options.

6-TRQ #8. What is the discovery process and how does it work?Answer: Discovery is the process by which each side may explore the merits of the other

side’s arguments by obtaining documentary and testimonial evidence. Any matter or material relevant to the civil action that is not privileged is subject to discovery.

Initially, interrogatories are passed to the opposing council.

Subsequent to interrogatories, opposing parties submit “requests to produce documents” to one another.

Third, attorneys start to take sworn testimony from opposing parties in the form of depositions.

The fourth and last stage of discovery is an attempt by counsel to get the other side to agree to certain basic aspects and facts of the case through “requests for admission.”

6-TRQ #9. What are the three major types of negotiated remedies and how do they differ?Answer: There are three major forms of negotiated remedies: out-of-court settlements,

arbitration, and mediation.

Out-of-court settlements occur when both sides come to a settlement position after examination of their own clients, the evidence, the qualities of their fact witnesses, the strength of their expert opinions, and other important aspects of the case.

In mediation, an independent, objective mediator will work with both sets of opposing counsel to help reach a settlement between the two (and their clients).

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An arbitrator is an independent third party who has the authority to determine the outcome of the case. Thus, the arbitrator acts like the judge and jury, listening to the primary aspects of each side’s case and deciding what he or she believes to be the most appropriate outcome based on the merits of the cases presented.

6-TRQ #10. How did the Sarbanes–Oxley Act address corporate governance and public accounting responsibilities?

Answer: The Act provides sweeping measures aimed at:• Establishing higher standards for corporate governance and accountability.• Creating an independent regulatory framework for the accounting profession.• Enhancing the quality and transparency of financial reports.• Developing severe civil and criminal penalties for corporate wrongdoers.• Establishing new protections for corporate whistleblowers.

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