END OF CHAPTER MATERIAL

CONCEPT CHECK

1. 1. Which of the following is not considered a component of corporate governance?
   1. Board of directors oversight
   2. IRS audits
   3. Internal audits
   4. External audits
2. 2. Good corporate governance is achieved when the interests of which of the following groups are balanced?
   1. Internal auditors and external auditors
   2. Shareholders and regulators
   3. Shareholders, the corporation, and the community
   4. Regulators and the community
3. 3. Over time, corporate leaders establish trust by being active leaders, stressing integrity, clarity, and consistency. This is referred to as
   1. internal control
   2. corporate governance
   3. fiduciary duty
   4. tone at the top
4. 4. Corporate governance is primarily concerned with
   1. enhancing the trend toward more women serving on boards of directors
   2. promoting an increase in hostile takeovers
   3. promoting the legitimacy of corporate charters
   4. emphasizing the relative roles, rights, and accountability of a company's stakeholders
5. 5. The governing body responsible for establishing the COSO framework for internal controls evaluations is the
   1. Treadway Commission
   2. SEC
   3. PCAOB
   4. FASB
6. 6. When financial information is presented properly and its correctness is verifiable, it is
   1. transparent
   2. compliant
   3. accurate
   4. accountable
7. 7. Which of the following nonaudit services may be performed by auditors for a public-company audit client?
   1. IT consulting regarding the general ledger system for a newly acquired division
   2. Programming assistance on the new division's general ledger system
   3. Human resource consulting regarding personnel for the new division
   4. Income tax return preparation for the new division
8. 8. Which of the following is not true regarding the requirements for reporting on internal controls under Section 404 of the Sarbanes–Oxley Act of 2002?
   1. Management must accept responsibility for the establishment and maintenance of internal controls and provide its assessment of their effectiveness.
   2. The independent auditor must issue a report on the effectiveness of internal controls.
   3. Management must identify the framework used for evaluating its internal controls.
   4. Management must achieve a control environment that has no significant deficiencies.
9. 9. In the corporate governance chain of command, the audit committee is accountable to
   1. the company's vendors and other creditors
   2. management and employees
   3. governing bodies such as the SEC and PCAOB
   4. the external auditors
10. 10. Section 806 of the Sarbanes–Oxley Act is often referred to as the whistleblower protection provision of the Act because
    1. it offers stock ownership to those who report instances of wrongdoing
    2. it specifies that whistleblowers must be terminated so as to avoid retaliation
    3. it protects whistleblowers' jobs and prohibits retaliation
    4. it provides criminal penalties for the alteration or destruction of documents
11. 11. Which of the following is true regarding the post-Sarbanes–Oxley role of the corporate leader?
    1. More emphasis is placed on strategic planning and less emphasis on financial information.
    2. The corporate leader must be more in tune with IT to provide corporate governance solutions.
    3. The corporate leader must be more focused on merger and acquisition targets.
    4. The corporate leader tends to be less involved with the board of directors.
12. 12. Many corporate frauds involve
    1. managers soliciting assistance from their subordinates
    2. a small deceptive act that intensifies into criminal behavior
    3. an earnings management motive
    4. all of the above

DISCUSSION QUESTIONS

1. 13. (SO 1) Why is tone at the top so important to corporate governance?
2. 14. (SO 1) Why do you think companies that practice good corporate governance tend to be successful in business?
3. 15. (SO 2) Which stakeholder group, internal or external, is more likely to be affected by corporate governance, and which has a direct effect on corporate governance?
4. 16. (SO 2) Explain how it is possible that a shareholder could be considered both an internal and an external stakeholder.
5. 17. (SO 2) Why is the board of directors considered an internal stakeholder group, when it is required to have members who are independent of the company?
6. 18. (SO 2) How can internal auditors maintain independence, since they are employees of the company?
7. 19. (SO 3) Identify the four functions of the corporate governance process.
8. 20. (SO 3) Describe the key connection between tone at the top and management oversight.
9. 21. (SO 3) Explain the connection between fiduciary duty and financial stewardship.
10. 22. (SO 4) Why do many accountants claim that corporate governance was born in the 1930s?
11. 23. (SO 4) What is the primary difference between the Securities Act of 1933 and the Securities Exchange Act of 1934?
12. 24. (SO 5, SO 6) Why did the SEC establish the PCAOB?
13. 25. (SO 5) Why can auditors no longer be involved in helping their audit clients establish accounting information systems?
14. 26. (SO 5) Under what conditions are auditors permitted to perform nonaudit services for their audit clients?
15. 27. (SO 5, SO 6) How has the Sarbanes–Oxley Act increased the importance of audit committees in the corporate governance process?
16. 28. (SO 5) Identify the six financial matters that must be certified by a company's top officers under the requirements of Section 302 of the Sarbanes– Oxley Act.
17. 29. (SO 5) Explain the relationship between Section 401 of the Sarbanes–Oxley Act and the concept of transparency.
18. 30. (SO 5) Explain the difference between management's responsibility and the company's external auditors' responsibility regarding the company's internal controls under Section 404 of the Sarbanes–Oxley Act.
19. 31. (SO 5) Explain why Section 409 of the Sarbanes–Oxley Act has placed more pressure on members of IT departments within public companies.
20. 32. (SO 5) How is the Sarbanes–Oxley Act forcing corporations to become more ethical?
21. 33. (SO 6) Why do corporate leaders see their jobs as more risky since the Sarbanes–Oxley Act became effective?
22. 34. (SO 6) Which governing body holds the top position of management oversight?
23. 35. (SO 6) Identify two ways that companies are making efforts to improve the financial stewardship of their managers.
24. 36. (SO 7) How can IT departments assist corporate managers in fulfilling their corporate governance roles?
25. 37. (SO 8) How is it that management's role as financial stewards may be considered a conflict of interest with their position as employees of the company?

BRIEF EXERCISES

1. 38. (SO 2) Why are shareholders sometimes considered internal stakeholders and sometimes considered external stakeholders?
2. 39. (SO 3) Is it possible for financial information to be accurate and complete, but not transparent? Similarly, is it possible for financial information to be transparent, but not accurate and complete? Explain.
3. 40. (SO 3) Earnings management involves lying about the company's financial results in order to provide a more favorable impression to investors. Earnings management is discussed in the section on financial stewardship. Explain how the other three functions of corporate governance can work together to help prevent earnings management within a corporation.
4. 41. (SO 4) Describe how the characteristics of the financial markets in the 1980s eventually led to the creation of the Sarbanes–Oxley Act of 2002.
5. 42. (SO 5) Although the Sarbanes–Oxley Act of 2002 applies to public companies, many private business organizations have been impacted by this legislation, especially if they are suppliers to a public company. Explain how this external stakeholder relationship can lead to the widespread application of Section 404 of the Act.
6. 43. (SO 6, SO 7) Describe at least three ways that the Sarbanes–Oxley Act and the increased attention to corporate governance have put more emphasis on the role of those responsible for the company's accounting information systems.
7. 44. (SO 8) Why do you think it is particularly challenging for companies to maintain ethical behavior during difficult financial times?

PROBLEMS

1. 45. (SO 3) List the six steps for establishing internal controls and describe how this process leads to stronger overall corporate governance.
2. 46. (SO 5, SO 6) List the items that must be certified by corporate management in accordance with the provisions of the Sarbanes–Oxley Act. Discuss how these responsibilities have likely changed the period-to-period activities of the certifying managers.
3. 47. (SO 6) Identify the costs and benefits of complying with the Sarbanes– Oxley Act of 2002. Do you think the costs are justified?
4. 48. (SO 2, SO 5) Using an Internet search engine, determine who the whistleblower was at Enron. Summarize the circumstances. What was the relationship of this person with the company? Was this an internal or external stakeholder?
5. 49. (SO 3, SO 8) Using an Internet search engine, search for the terms “guilty as charged” + “California Micro Devices” in order to find an article about the company, California Micro Devices. Identify the related corporate governance issues.
6. 50. (SO 3, SO 8) There are five types of earnings management techniques presented in this chapter. Provide two or three specific examples of how corporate leaders could pull off these types of fraud, as well as the internal control activities that could be used to prevent them.

CASES

1. 51. Do you think the tone at the top of organizations like Enron and WorldCom led to their demise? In support of your answer, identify specific actions of top managers at each of these companies. In order to answer this question, you may wish to perform research on the conditions that brought these companies down.
2. 52. Through online research, locate the code of conduct for the top management of a real-world company. Discuss the importance of each component of this code in terms of ethics and its relation to the concept of corporate governance.

CONTINUING CASE: ROBATELLI'S PIZZERIA

Refer to the Robatelli's Pizzeria case at the end of Chapter 1. Answer the following questions:

1. From the facts of the case, identify Robatelli's internal and external stake holders.
2. Other than by its product offerings (pizza, etc.), identify any ways that Robatelli's Pizzeria influences its business community.

SOLUTIONS TO CONCEPT CHECK

1. 1. (SO 1, SO 2) b. IRS audits are not considered a component of corporate governance. Although income tax returns are a form of financial reporting, they are not considered part of the corporate governance structure because management does not have the same level of responsibility for tax returns.
2. 2. (SO 1) Good corporate governance is achieved when the interests of c. shareholders, the corporation, and the community are balanced. For each of the other responses, the stakeholder groups are not expected to have aligned interests; rather, they each have diverse interests in the corporation.
3. 3. (SO 1) Over time, corporate leaders establish trust by being active leaders, stressing integrity, clarity, and consistency. This is referred to as d. tone at the top.
4. 4. (CIA Adapted) (SO 1) Corporate governance is primarily concerned with d. emphasizing the relative roles, rights, and accountability of the company's stakeholders. This response is consistent with the definition of corporate governance which states that the company's leadership is held accountable for building shareholder value and creating confidence.
5. 5. (SO 2) The governing body responsible for establishing the COSO framework for internal controls evaluations is the a. Treadway Commission.
6. 6. (SO 3) When financial information is presented properly and its correctness is verifiable, it is c. accurate.
7. 7. (SO 5) d. Income tax return preparation for a new division is a nonaudit service that may be performed by auditors for a public-company audit client. Each of the other services is expressly prohibited by Section 201 of the Sarbanes-Oxley Act.
8. 8. (CPA Adapted) (SO 5) The statement d. Management must achieve a control environment that has no significant deficiencies is not true regarding the requirements for reporting on internal controls under Section 404 of the Sarbanes–Oxley Act of 2002. Although management would certainly strive for a control environment free of deficiencies, there is no requirement for such. Each of the other responses represents a requirement of Section 404 of the Act.
9. 9. (SO 6) In the corporate governance chain of command, the audit committee is accountable to c. governing bodies such as the SEC and PCAOB. Refer to Exhibit 5-3.
10. 10. (SO 5) Section 806 of the Sarbanes–Oxley Act is often referred to as the whistleblower protection provision of the Act because c. it protects whistleblowers' jobs and prohibits retaliation.
11. 11. (SO 6) The post-Sarbanes–Oxley role of the corporate leader is b. more in tune with IT to provide corporate governance solutions. Each of the other answers is more characteristic of the CEO's role prior to the Act.
12. 12. (SO 8) Many corporate frauds involve d. all of the above, including managers soliciting assistance from their subordinates, small deceptive acts that intensify into criminal behavior, and an earnings management motive.