Quiz 5: Fraud in Financial Statements and Auditor Responsibilities


1. Accrual earnings are income that has been earned but not yet received in cash. For example, a contractor who completed a construction project but not paid yet. These are considered "earned" when the customer finishes the purchases, e.g. contract signed or delivery made. The revenue on the company's financial statements were inflated due to recognizing income that has not been earned. The objectionable practices listed • 35 month days, extends the revenue recognition period • Dating contracts with earlier dates that were signed later The company violated its responsibility to its stockholders to keep accurate records. They also misled stockholders of their earning strength. 2. Just because a crime doesn't hurt anyone doesn't mean that there are no repercussions. By backdating contracts the revenues were inflated, making the company look better financially than it actually was. Investors use this information for their portfolio. But since this information is not accurate this causes losses to investors later on when the revenues have to be corrected for. The company also gives a poor ethical image for its employees to follow by condoning such practices. 3. These companies need to realize that the numbers are only allocated, shifted. By reporting revenues earned say in December when it's actually earned in January, it only shifts the numbers down. The company will have to keep up this practice. Furthermore, shifting numbers doesn't help the company financially in the long run. In the long run, their revenue are determined by their products and services not by shifting numbers.

Risk assessment is the identification of risk factors that will negatively impact a business. For auditing the important risk are fraud. Fraud is a deliberate attempt to deceive, such as lying about business expenses or misreporting the actual revenue earned. By identifying fraud risk, auditors can advise management on safeguards to prevent it. Doing so improves internal control.

1. Yes, the auditors should be held liable for failing to discover fraud. This is the duty of auditor to detect and prevent fraud and any failure to detect fraud and reporting to the board of directors will hold them responsible. There must be an effective system of internal controls and an independent audit function for defense against fraud. While conducting audit, it is the ethical and moral duties of an audit professional that auditor must perform his work with due diligence, exercise reasonable care, must be loyal and honest and work in obedience. The auditors applied all the reasonable care and due diligence to find the proper financial accounts of the corporation but failed to do so. E W was loyal towards their work and was abiding all the laws and regulations but when B tries to pull everything off then the auditor did not act against them as they did not want to lose the ZZZZ best account. This shows that auditor should be made liable as he divert from their ethical obligations. 2. There was enough paper work of the accounts of ZZZZ but there were no actual reports of the restoration sites by the previous auditors. The E W wanted to confirm all the revenues and property of the company. When the auditor inspected the restoration sites, they failed to take the reasonable steps to find out the actual papers of the site to check out to whom the site belong. E W also did not want to lose their client because of good accounts of the company. This shows that E W's relationship with ZZZZ influenced the work done on audit. The auditor came to know about some red flags and they have to work to find the true story behind the accounts of the company. Instead, they supported the company to pursue with the illegal accounting and frauds just to have good records with the company. 3. After looking into the data, we can see that there is sudden increase in the volume of sales from the year 1985 to 1986 which is up to three times more than in the year 1985. Not only sales, the current liabilities, cost of goods sold, accounts receivable were also increased three times more than in year 1985. The inquiries must be made regarding the documents, bank account statements and all the revenues that the company has earned in the financial year 1986. However, increase in the sales is normal phenomenon in this process but the enormous increase would be checked properly by the auditors honestly with due diligence. 4. The fraud triangle describes three conditions requires to be present when fraud occurs. The conditions are as follows: a. Incentive/ pressure b. Opportunity c. Rationalization. The sum up of all these condition is that when the employee has an incentive or pressure then this provides an opportunity to commit fraud or act as a perpetrator. Those involved employee are able to rationalize committing a fraudulent act. In this case, B received incentives for work as carpet cleaner. He has the pressure to become the multi millionaire and started with a fiction idea of insurance restoration job. The opportunity to execute its plan was given by the bank process of clearing the checks. From there B got an idea to kite checks. B started working on the fraud ideas over the phone with the banks to obtain loans by falsifying accounts and revenue. B found one way from another to fraud banks, auditors and other third parties. 5. The Min started working as fraud detector and became the senior pastor after releasing from the jail. But his work of fraud detector provides him the opportunity to involve into the evil ways of fraud. When Min finds the fraud of L, he told Mar about it. Mar then instituted the lawsuit against L which results into the decline in the value of the share of his company. Min bets on the fall in stock and also forged the document to allege the misconduct upon the L in order to win the bet. This betting provides him the opportunity. 6. Kohlberg has six stages of moral development. They are as follows: i. Obedience and punishment orientation. ii. Self interest orientation. iii. Interpersonal accord and conformity. iv. Authority and social order maintaining orientation. v. Social contract orientation. vi. Universal ethical principles. Min's action after being released from the jail is similar to the stage two of the K's stages of moral development. Stage two is the self interest orientation which means that individual is only concerned about himself and little care about the needs of other. Similarly is the case of Min, who only cares about his money and earnings and does not care about the other's loss because of his behavior as he done to the L. Min fraudulently forged the document to allege fraud against the Lennar in order to win the bet in which huge amount was involved. This shows that Min's behavior satisfied the second stage of moral development.