Quiz 5: Fraud in Financial Statements and Auditor Responsibilities


Fraud Triangle: Fraud triangle is the study of the fraud, which is committed by the employee and is committed when they go through one or more situation. The employees get incentives on committing the fraud, scopes for committing fraud and capacity to rationalize the fraud committed. The ethical obligations are the act done by any person as per the code of conduct rule of ethics. This is based on the sense of what is right and what is wrong, and a person stops doing wrongs as he is bound by the sense of ethical conduct. The giving voice to value is the practical approach of understanding how a practical thing can be done in the correct manner. This is the task of post decision making which helps in drawing conclusion on how the things are done correctly, when the right thing to do is known. In the above case, Mr. RR has committed a fraud of 50,000 dollars for entertaining demand of extramarital affairs, and seeking help from Mr. VV, his colleague covering the wrong doings. Moreover, Mr. RR has also committed similar kind of fraud of 20,000 dollars in the past. As per the case, Mr. RR could easily pass the money from the frauds of the company, as it was not difficult to work against the internal control of the company. Mr. RR knew that his colleague, Mr. VV will help him cover the fraud through fake entries in book, which helped him to commit the fraud. Additionally, Mr. RR was sure to rationalize the wrong doings as he had done similar fraudulency in the past and was saved by Mr. VV. Mr. VV entered fake book entries of the company and saved Mr. RR, as both was involved in similar fraudulency. In the case, Mr. VV is in the situation, where he should help his friend, Mr. RR. Mr. RR is at risk for the wrongful act and there is some duty of care to be taken of, by Mr. VV towards Mr. RR. Mr. VV is also bound by the ethical code of conduct and professionalism which states that he should not get intimidated Mr. RR and let him get away. Mr. VV should not be reluctant to speak about the wrongful act of Mr. RR in front of the auditor. Mr. VV should not hold the shortcomings in the internal control of the company. Mr. VV's ethical obligation will be not hiding the wrongful act of Mr. RR. Mr. VV should blow the whistle against Mr. RR about the wrongful act conducted for two years. Mr. VV finds tough to take any action against his friend Mr. RR for not conducting ethically, as his link with the auditor is already at stake. Mr. VV could take a non-ethical action and help Mr. RR, which will be against the ethical code of conduct. Mr. VV should give voice to his social values and bring the true story in front of the auditor.

Audit risk assessment Audit risk assessment is the evaluation of risk associated with fraud and addressing those frauds to those who are charged with responsibilities. The objectives of audit risk management are as follows: 1. To know, the views of management and others from the organization, the risk of fraud and how they are addressed. 2. To know if there has been any biasness from the auditors in performing analytical procedures that is financial statements comparisons overtime and ratio analysis. 3. To know if there is any fraud risk factor. 4. To know if there is any material misstatement by considering information like factors associated with acceptance of clients and interim financial results. During the audit planning, the assessment of risk is not the only thing that the auditor should keep in mind but, maintaining the professional skepticism is one of the most important things that have to be considered. The auditor should keep a healthy attitude instead of creating a mess for the management just because it is keeping a check on the management. And that's how the management reacts in the same way and cooperates with the auditors during the assessment of risk. And, that's how the risk assessment sets the tone for entire audit engagement during the audit planning.

Audit committee responsibilities The responsibility is to identify risks of fraud, implementing the measures of antifraud, and maintaining professional skepticism. Auditors are also responsible for ensuring a zero tolerance culture in the organization. Fraud risk assessment It evaluates the evidence of the clients before auditors agree to do the audit. It focuses on finding out if any significant statement is misstated and to maintain professional skepticism. Generally accepted auditing standards (GAAS) These are the standards according to which an auditor plans and reports the audit results and measure the quality and objectives of an audit. It makes judgment regarding the evidence of audits, and how sufficient, reliable the evidences are. 1. In this case, the person M managed to falsify his company's (Company Z) customers, its financial statements, its bank accounts and forged money by kiting the checks. He was able to do this because it was his own company, and not even real and there was no internal control system. The auditors were not able to get the facts that were allowing the person to commit the fraud because the company E (auditor's firm) did not want to lose company Z as a client, which shows how irresponsible the auditors were. The auditors must make it sure to keep the client's company free from any frauds by active inspection. The auditors must not let any risks of frauds unnoticed just because of the fear of losing their clients. But, in this case this happened. So, we can say that the auditors are responsible for not being able to know the fraud is being committed. 2. The red flags, as a sign of risk, existed in this case in the following situations: a. The person M risked creating a fake company and fooling the auditors into thinking the business to be real. b. He committed a fraud by kiting the check taking advantage of float and the checks being used as unauthorized credits. c. He managed to set a fake restoration site and make his helpers help him to make it sure that banks trust the company is doing restoration business. d. With the borrowed loan the person M bought many of his personal luxuries, even though the loan was taken committing fraudulent acts. e. The auditors did not bother to inspect the accounts and restoration sites diligently because of the fear of losing their clients. In this case, the person M was involved in the fraudulent acts even before company E was hired to audit the accounts of the company Z and has already committed many frauds including showing higher amounts in the bank accounts by kiting the checks, and faking restoration sites. It is a prime responsibility of the auditor to check the risks of frauds and significant misstatements in the books of the company before it starts to audit the potential clients. But, the auditors in this case, failed to do that and did not make any efforts to assess the risk of frauds. 3. a. The purpose of performing analytical review procedures are as follows: It shows how the audit went and it gives reports of any issues that may cause of a risk of frauds. The audit procedures' nature, timing, and extend is determined by performing the analytical reviews which tests the material misstatements risks. The analytical review procedures make a comparison of the actual values that have been recorded by the auditors and what has been expected by them. It analyzes the financial data by studying the relationships between financial and non-financial data. b. Analysis of financial data has to be made in order to know that if any frauds is being committed by the company. Any unusual changes identified in the analysis might mean that the company is trying to hide something. Following analysis must be made in order to see whether the financial relationships are reasonable or not: Current ratio : It is the ratio of current assets to current liabilities. The company usually maintains the current ratio consistent, and a sudden change would mean the company is trying to hide something. In this case also, the company's current ratio had a sudden big change. This could mean that the company is up to something and analysis should be done. Quick ratio : It means the ratio between the current liabilities and the quick assets which can be liquidated when a need arise to pay the liabilities. It should be seen that the quick assets are enough to cover the liabilities. Quick assets are cash, securities, and account receivables. In this case, comparing quick assets and the current liabilities, it can be seen that the current liabilities are increasing more than the quick assets are increasing. This would mean that the company is unable to cover the current liabilities in the times of need. So, the auditors must keep a skeptical look at the financial statements. Receivable turnover ratio : It is the ratio of net sales to average sales receivable. If a fraud is committed and the fictitious sales have been recorded then the account receivables will never be collected. In this case, even though the sales are increased the account receivable is not increasing that rapidly, which could mean that fake sales are showing in the financial statements. This means that the auditors must check the financial statements thoroughly. So, it doesn't seem like the financial statements and the relationships of their data are reasonable. 4. In this case, the person M committed a felony by embezzling money from the church which were intended to be used as church donations, and, he fooled a widower by making him to donate $75000 for a hospital in Sudan which he used for his own benefits. Moreover, he also stole $300,000 from a widowed grandmother, raising her granddaughter. He admitted that he stole, from the internal revenue services, an amount of $3 million. He was able to continue his wrong doings for over a year, even though he was sentenced to a five year jail in addition to what he was sentenced to before afterwards. The reasons that he was able to commit the felony could be the following: a. He had become a reputed pastor in the church where he was trusted. And, he used this trust to satisfy his greedy nature. b. He was able to impress the investors in the Wall Street, and got enough amount from them to target bigger frauds. c. He was able to direct the mind of the fraud discovery authorities to the story of massive fraud committed by the person L, which was not substantive.