Business & Professional Ethics for Directors, Executives & Accountants, 6e

Multiple Choice Questions

Chapter 2 Enron Events Motivate Governance & Ethics Reform
1) Most observers agree that Enrons problems were caused by:
a.
b.
c.
d.
e.

Managements failure to exercise adequate oversight

Failure of the audit committee to exercise adequate oversight
Auditors lack of independence
Deficiencies in audit procedures
Failure of the board of directors to exercise adequate oversight

ANSWER: e
2) Under the U.S. accounting rules, the following conditions were required to consider special purpose
entities (SPEs) to be independent parties:
a. Independent investment of less than 3% of the SPEs equity and independent control of the
SPE
b. Independent investment of at least 3% of the SPEs equity and independent control of the
SPE
c. Substantive investment of at least 3% of the SPEs equity and independent control of the SPE
d. Independent investment of at least 3% of the SPEs assets at risk and independent control of
the SPE
e. Substantive investment of less than 3% of the SPEs assets at risk and independent control of
the SPE
ANSWER: d
3) The Board of Directors paramount duty is:
a.
b.
c.
d.
e.

To determine managements compensation

To safeguard the interest of the companys stakeholders
To safeguard the companys assets
To formulate the companys strategy
To safeguard the interest of the companys shareholders

ANSWER: e
4) The independence of the Enron Board of Directors was compromised by:
a.
b.
c.
d.
e.

Family ties between the company and certain board members

Employment ties between the company and certain board members
Financial ties between the company and certain board members
Fiduciary ties between the company and certain board members
All of the above

Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

ANSWER: c
5) The following three broad duties stem from the fiduciary status of corporate directors:
a.
b.
c.
d.
e.

Obedience, loyalty, and confidentiality

Obedience, loyalty, and due care
Loyalty, due care, and confidentiality
Obedience, loyalty, and good faith
Loyalty, confidentiality, and good faith

ANSWER: b
6) In order to ensure an investment-grade credit rating, Enron began to emphasize the following three
actions:
a.
b.
c.
d.
e.

Reducing accruals, increasing cash flow, and lowering debt

Smoothing accruals, increasing cash flow, and lowering debt
Increasing cash flow, lowering debt, and smoothing earnings
Increasing cash flow, lowering earnings and decreasing option expense
Increasing cash flow, lowering debt, and decreasing option expense

ANSWER: c
7) Which of the following was not a committee in Enrons Board?
a.
b.
c.
d.
e.

Risk Management Committee

Executive Committee
Finance Committee
Audit and Compliance Committee
Nominating Committee

ANSWER: a
8) Enron referred to this transactions as monetizing or syndicating its assets:
a.
b.
c.
d.
e.

Buy more assets using syndicated loans

Sell assets to third parties and record cash income as earnings
Hedge the companys assets
Lend money to third parties to buy assets
Recording profits on energy derivatives trading

ANSWER: b
9) Enron created the following SPE(s) to hide off-balance sheet liabilities, recognize revenues early ,
and recognize profits on own shares:
a.
b.
c.
d.
e.

LJM
LJM1/Rhythms
LJM2/Raptors
Chewco/JEDI
LJM3
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

ANSWER: d
10) Which of the following was not a flaw found in LJM1 arrangements?
a.
b.
c.
d.
e.

Profits were improperly recorded on treasury shares used or sheltered by non-existing hedges
Enron was hiding employee stock option expense
Enron was hedging itself
Enron had to advance treasury shares to buy them back at preferential rates
Enron officers and their helpers benefited

ANSWER: b
11) At the time of Enrons collapse, the prevailing treatment for employee stock option expense was:
a.
b.
c.
d.
e.

Record stock options only when and if exercised, at exercise price

Record all stock options when issued, at exercise price
Record all stock options at market price
Record stock options only when exercised at market price
Record not exercised options at market price

ANSWER: a
12) Which of the following was not a conflict of interest that Arthur Andersens personnel encountered?
a.
b.
c.
d.

Auditing their own work as SPE consultants

Losing a very large client
A partner reviewed another partners work
Internal debates about Enrons questionable accounting treatments were not discussed with
the audit committee
e. Audit staff leaving the firm to work for Enron
ANSWER: c
13) Which of the following was not among Arthur Andersens shortcomings in conducting Enrons audit?
a.
b.
c.
d.
e.

Lack of competence
Failure of quality control standards
Misunderstanding of auditors fiduciary role
Inconclusive testing of control
Insufficient information provided by Enrons staff

ANSWER: d
14) Which of the following was not a strategy used by Enron to avoid taxes?
a.
b.
c.
d.
e.

Deduction of losses twice

Shifting depreciable assets to non-depreciable assets
Tax deductions for repayment of debt principal
Duplication of single economic loss
Generation of fees for serving as an accommodation party for another taxpayer
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

ANSWER: b
15) In general terms, WorldCom overstated its reported net income by:
a.
b.
c.
d.
e.

Generating false expenses

Booking false revenue
Capitalizing line costs
Amortizing line costs quicker than allowed under GAAP
Recognizing future periods revenue

ANSWER: c
16) This type of manipulation is known as cookie jar accounting:
a.
b.
c.
d.
e.

Manipulation of profits through reserves or provisions

Incorrect classification of long term debt as equity
Incorrect classification of regular expenses as extraordinary items
Manipulation of profits through booking revenue in early periods
Manipulation of reserve for uncollectible amounts

ANSWER: a
17) After SOX, which of the following is not a prohibited non-audit service for external auditors?
a.
b.
c.
d.
e.

Appraisal or valuation services

Bookkeeping and other services
Legal services
Tax services
Internal audit outsourcing

ANSWER: d
18) Which of the following is not a requirement imposed by the SOX Corporate Governance
Framework?
a. The audit committee must be comprised solely by independent directors
b. The audit committee is responsible for appointing the companys external auditor
c. The audit committee must establish procedures to allow employees to submit anonymous
complaints
d. The audit committee must approve non audit services to be provided by the auditors
e. The audit committee must be comprised solely by financial experts
ANSWER: e
19) SOX increased the time requirement and legal risk for company directors. These requirements will
likely:
a. Increase the number of directors in the board
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

b.
c.
d.
e.

Reduce the number of directors in the audit committee

Increase audit fees
Reduce the number of boards that each director sits on
All of the above

ANSWER: d
20) These companies are more likely to voluntarily adopt improved governance measures:
a.
b.
c.
d.
e.

Larger companies
Less profitable companies
Foreign companies
Smaller companies
Private companies

ANSWER: a

Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010