Fraud Risks in Financial Statements
42 Questions
0 Views

Fraud Risks in Financial Statements

Created by
@StrongerJadeite5982

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the first phase of misappropriation of assets?

  • The identification of victims
  • The cover-up
  • The fraudulent act (correct)
  • The conversion of assets to the fraudster's use

    • Which component of the Fraud Triangle pertains to the capability to commit fraud due to weak internal controls?

  • Motivation
  • Opportunity (correct)
  • Rationalization
  • Pressure

    • What is a recommended procedure during audit team brainstorming discussions regarding fraud risk?

  • Set a strict performance metric
  • Create a financial report
  • Evaluate management's lifestyle choices
  • Discuss incentives and pressures on management (correct)

    • Which of these is NOT a condition typically found in the Fraud Triangle?

    <p>Complicity</p> Signup and view all the answers

    What could signify an improper revenue recognition risk according to fraud risk assessment?

    <p>Unusual transactions without significant rationale</p> Signup and view all the answers

    What pressure might lead management to commit fraudulent financial reporting?

    <p>Company profitability being threatened</p> Signup and view all the answers

    Which of the following is a potential response to threats identified during fraud risk assessments?

    <p>Implementing stricter internal controls</p> Signup and view all the answers

    Which factors are considered when assessing the risk of management overriding controls?

    <p>Reviewing account estimates for biases</p> Signup and view all the answers

    What is the main purpose of a schedule of interbank transfers?

    <p>To detect check kiting.</p> Signup and view all the answers

    Which statement is true regarding the impact of technology on check kiting?

    <p>Technology and scrutiny have decreased check kiting.</p> Signup and view all the answers

    Which action is NOT an extended procedure for detecting cash fraud?

    <p>Conduct random audits of bank employees.</p> Signup and view all the answers

    What is an important aspect of a standard bank confirmation inquiry?

    <p>It serves to confirm both deposit and loan balances.</p> Signup and view all the answers

    Which of the following is part of the FASB 5-step process for revenue recognition?

    <p>Determine the transaction price.</p> Signup and view all the answers

    Which item is considered evidence of revenue recognition according to SEC guidance?

    <p>Persuasive evidence of an arrangement.</p> Signup and view all the answers

    Which type of confirmation request is increasingly utilized by banks?

    <p>Electronic confirmation requests.</p> Signup and view all the answers

    Which of the following is NOT a basic activity in the revenue and collection cycle of a manufacturing company?

    <p>Conducting market research.</p> Signup and view all the answers

    Which of the following is NOT a key control procedure in the revenue and collection cycle?

    <p>Customer Satisfaction Surveys</p> Signup and view all the answers

    What is the primary purpose of using confirmations in auditing accounts receivable?

    <p>To verify the existence of accounts.</p> Signup and view all the answers

    Which inherent risk is associated with revenue recognition during auditing?

    <p>Cut-off</p> Signup and view all the answers

    When is performing analytical procedures useful in auditing?

    <p>When comparing current financial data with past performance.</p> Signup and view all the answers

    Which factor is most likely to affect the reliability of confirmations?

    <p>The previous audit experience.</p> Signup and view all the answers

    What does the allowance for doubtful accounts typically represent?

    <p>The projected loss from uncollectible receivables.</p> Signup and view all the answers

    What is the primary purpose of comparing the PO number on the Bill of Lading (BOL) with the company Purchase Order (PO)?

    <p>To verify the accuracy of received items</p> Signup and view all the answers

    Which of the following statements is correct regarding positive confirmations?

    <p>They are used when inherent risk is assessed as high.</p> Signup and view all the answers

    Which control procedure helps ensure that unauthorized purchases do not occur?

    <p>Separation of duties</p> Signup and view all the answers

    What is the consequence of improper revenue recognition in financial reports?

    <p>Inaccurate assessment of company performance.</p> Signup and view all the answers

    What is the significance of verifying the completeness assertion in the acquisition cycle?

    <p>To ensure all liabilities have been recorded</p> Signup and view all the answers

    What does setting detection risk involve?

    <p>Evaluating the risk of material misstatement.</p> Signup and view all the answers

    What procedure would most likely help in identifying unrecorded liabilities?

    <p>Examine unmatched invoices</p> Signup and view all the answers

    What procedure is important for confirming the balances of accounts receivable?

    <p>Performing a cut-off test.</p> Signup and view all the answers

    Which of the following is NOT a part of physical controls related to inventory management?

    <p>Reconcile bids from vendors</p> Signup and view all the answers

    What action is essential when examining receiving reports near year-end to ensure proper cutoffs for purchases?

    <p>Check for matching vendor invoices</p> Signup and view all the answers

    What should be reviewed to verify the existence and accuracy of selected vendors' bids?

    <p>Review documentation regarding vendor selection</p> Signup and view all the answers

    Which of the following actions can confirm account payables even for suppliers with zero balances?

    <p>Confirm accounts payable with suppliers</p> Signup and view all the answers

    Which method is NOT typically used to confirm fixed assets?

    <p>Analyzing the profitability of fixed assets</p> Signup and view all the answers

    What is a primary purpose of recalculating depreciation expense?

    <p>To evaluate reasonableness of useful life and salvage value</p> Signup and view all the answers

    Which indicator might suggest potential fraud in accounts payable?

    <p>Vendor invoices that are always in round numbers</p> Signup and view all the answers

    What is a common inherent risk associated with the payroll cycle?

    <p>Ghost employees on the payroll</p> Signup and view all the answers

    Which step in the payroll process ensures accuracy in reported hours worked?

    <p>Employees recording hours worked using time sheets</p> Signup and view all the answers

    What is NOT a typical check auditors might perform when searching for fraud in accounts payable?

    <p>Reviewing detailed contracts with suppliers</p> Signup and view all the answers

    What is the correct treatment of lease agreements for capital leases?

    <p>Should ensure proper footnote disclosure</p> Signup and view all the answers

    In payroll activities, who is responsible for authorizing payroll-related transactions?

    <p>Supervisory personnel</p> Signup and view all the answers

    Study Notes

    Fraud Risks in Financial Statements

    • Management can intentionally mislead the marketplace by issuing fraudulent financial statements, increasing the risk of material misstatement.
    • Misappropriation of assets is the use of fraudulent means to take money or other property from an employer.
    • Misappropriation of assets consists of three phases: the fraudulent act, the conversion of money or property to the fraudster’s use, and the cover-up.

    Fraud Risk Assessment Considerations

    • Assume improper revenue recognition presents a fraud risk.
    • Identify risks that could have led to management overriding controls.
      • Examine journal entries and other adjustments.
      • Review account estimates for biases.
      • Evaluate the business rationale for significant unusual transactions.

    Audit Team Brainstorming Discussions

    • Required Procedure:
      • Discuss the fraud triangle, including incentives and pressures, opportunities, and rationalization of fraud.
      • Consider the risk of management override of controls.
      • Look for indicators of earnings management.
      • Maintain continuing professional skepticism.
      • Develop potential responses to fraud threats.
    • Set the proper tone for the engagement.
    • Discussions should be ongoing throughout the engagement.

    The Fraud Triangle

    • Consists of three elements: opportunity, incentive/pressure, and rationalization.
    • Incentives/Pressures (Motivation) for Fraudulent Financial Reporting:
      • Threatened company profitability.
      • Management pressure to meet performance expectations.
      • Management compensation heavily tied to performance.
    • Incentives/Pressures (Motivation) for Misappropriation of Assets:
      • Financial obligations.
      • An adverse relationship with the company.
    • Opportunity for Fraudulent Financial Reporting:
      • Organizational structure.
      • Ineffective monitoring of management.
      • Internal control weaknesses (or management override ability).
    • Opportunity for Misappropriation of Assets:
      • Access to liquid assets (cash).
      • Internal control weaknesses.

    Schedule of Interbank Transfers: Check Kiting

    • Deliberately floating funds between two or more bank accounts to create the impression of a larger cash balance than exists.
    • Technological advancements and bank scrutiny have reduced this possibility in recent years.
    • Auditors use a schedule of interbank transfers to potentially detect check kiting.

    Other Extended Procedures for Detecting Fraud Involving Cash

    • Count and recount petty cash on the same day.
    • Examine endorsements on canceled checks.
    • Retrieve customer checks.
    • Use marked coins and currency.
    • Analyze the mix of cash and checks in deposits.
    • Measure deposit lag time.
    • Conduct document examination.
    • Initiate inquiries.
    • Use covert surveillance.
    • Perform horizontal and vertical analyses.
    • Employ net worth analysis.
    • Utilize expenditure analysis.
    • Conduct reasonableness tests.

    Confirmation of Bank Balances

    • Standard Bank Confirmation Inquiry:
      • Mailed under the auditor's control.
      • Used to confirm deposit balances and loan balances.
      • Can be used to request information about contingent liabilities and secured transactions.
    • Electronic Confirmation Requests:
      • Many banks now only handle confirmation requests electronically.
      • Improves control over delivery and receipt of confirmation requests.
      • Allowed by professional auditing standards.

    Revenue Recognition

    • Revenue must be (1) realized or realizable and (2) earned.
    • SEC Guidance:
      • Persuasive evidence of an arrangement exists.
      • Delivery has occurred or services have been rendered.
      • The seller's price to the buyer is fixed or determinable.
      • Collectability is reasonably ensured.

    Revenue From Contracts With Customers

    • FASB 5-Step Process for Revenue Recognition:
      1. Identify the contract(s) with a customer.
      2. Identify the performance obligations in the contract.
      3. Determine the transaction price.
      4. Allocate the transaction price to the performance obligations in the contract.
      5. Recognize revenue when (or as) the entity satisfies a performance obligation.

    Basic Activities in the Revenue / Collection Cycle

    • Receiving and processing customer orders.
    • Delivering goods and services to customers.
    • Billing customers and accounting for accounts receivable.
    • Collecting and depositing cash received from customers.

    Audit Evidence in Management Reports and Data Files

    • Pending order and back order master file.
    • Customer master file.
    • Price list master file.
    • Sales detail (journal) file.
    • Sales analysis report.
    • Accounts receivable listing and aging.
    • Cash receipts listing.
    • Customer Statements.

    Using the Audit Risk Model

    • Set audit risk at desired levels (typically low).
    • Assess the risk of material misstatement, incorporating inherent risk based on the nature of the account balance or class of significant transactions and control risk based on understanding internal control.
    • Set detection risk at the significant account and assertion level based on the level of audit risk and risk of material misstatement.

    Inherent Risks in the Revenue and Collection Cycle

    • Improper Revenue Recognition:
      • Cut-off.
      • Bill and Hold.
      • Channel Stuffing.
    • Returns and Allowances:
      • Potential for material misstatement.
    • Collectability of Receivables:
      • The possibility of uncollectible accounts.

    Revenue and Collection Cycle: Key Control Procedures

    • Separation of Duties:
      • Separate functions for recording, authorization, and custody.
    • Authorization of Transactions:
      • Write-offs.
      • EDI transactions.
      • Credit checks prior to approving sales.
      • Pricing.
    • Access to Assets:
      • Shipping department.
      • Lock box account.
    • Adequate Documents and Records:
      • Pre-numbered sales orders, shipping documents (bills of lading), sales invoices.
      • Remittance advice.
    • Independent Checks on Performance:
      • Comparing the A/R subsidiary ledger to the general ledger.
      • Sending monthly statements to customers.

    Auditing Accounts Receivable

    • Test the Accounts Receivable aged trial balance.
    • Confirm balances.
    • Perform analytical procedures.
    • Test sales cut-off.

    Analytical Procedures for the Revenue and Collection Cycle

    • Sales Revenue:
      • Comparisons with previous periods.
      • Comparisons with industry standards.
    • Allowance for Doubtful Accounts, Bad Debt Expense:
      • Bad Debt Expense as a percentage of Sales.
      • Allowance for Doubtful Accounts as a percentage of Gross Receivables.
    • Accounts Receivable:
      • Days Sales in Accounts Receivable.
      • Accounts Receivable Turnover.

    Using Confirmations

    • Primarily used for verifying existence.
    • Factors influencing the reliability of confirmations:
      • Previous audit experience.
      • Intended recipient of the confirmation.
      • Type of information being confirmed.
    • Auditors may confirm entire balances or individual transactions.

    Types of Confirmations

    • Positive Confirmations:
      • A small number of accounts are involved.
      • A large number of errors are anticipated.
    • Negative Confirmations:
      • The combined assessed level of inherent and control risk is low.
      • A large number of small balances are involved.
      • The auditor has no reason to believe that recipients of the requests are unlikely to give them consideration.

    Control Procedures in the Cash Disbursement Process

    • Information Processing Controls:
      • Compare the PO number on the Bill of Lading (BOL) with the company’s PO.
      • Compare quantities against the receiving report and purchase order.
      • Compare prices against the quoted price or catalog listing.
      • Recompute vendor invoices.
      • Determine when to pay the invoice.
      • Properly prepare the voucher.
    • Separation of Duties:
      • Authorization of the purchase is done by the purchasing department.
      • Custody of the inventory item(s) is held by the receiving department and ultimately the requesting department.
      • Transactions are recorded by general accounting (control account) and accounts payable department (subsidiary accounts).
      • Reconciliation of liabilities to customer statements and the general ledger account.
      • Bids are received by someone independent of the purchasing decision.
    • Physical Controls:
      • Prepare a receiving report upon initial receipt of inventory.
      • Count and verify inventory quantities upon delivery to the inventory warehouse.
      • Restrict access to inventories by keeping them in a secured location.
    • Performance Reviews:
      • Compare purchases data with data from previous years or expected purchases data.
      • Review bids to ensure documentation exists regarding the selection of the vendor.

    Substantive Procedures in the Acquisition and Expenditure Cycle

    • Completeness Assertion - search for unrecorded liabilities:
      • Inquire about procedures for identifying and recording liabilities.
      • Review cash disbursements occurring after year-end.
      • Examine unmatched vendor statements or invoices.
      • Examine unmatched receiving reports occurring near year-end.
      • Scan the open purchase order file.
      • Trace unpaid vouchers in the accounts payable ledger to receiving reports.
      • Confirm accounts payable with regular suppliers (even those with zero balances).

    Purchase Cutoffs

    • Verify cut-offs for purchases:
      • Examine receiving reports and vendor sales invoices occurring around year-end to ensure inventory received is included in the appropriate period.

    Auditing Fixed Assets

    • Physically inspect or confirm fixed assets.
      • Both existing and newly acquired items.
      • Confirm assets leased to others under capital leases.
    • Depreciation Expense:
      • Recalculate using useful life, salvage value, cost, and method.
      • Evaluate the reasonableness of useful life, salvage value, etc.
      • Is depreciation consistent with company policy (half-year conventions)?
    • Lease Agreements:
      • Verify the proper treatment (capitalized or operating).
      • Ensure disclosure in footnotes is appropriate.

    Auditing Costing and Expense Accounts

    • Analytical procedures (e.g., sales commissions).
    • Agree to related balance sheet accounts (e.g., depreciation).
    • Substantive tests of transactions (e.g., purchases).
    • Vouch details (e.g., legal expense).

    Fraud in Accounts Payable

    • If the review for fraud risk identifies a potential significant risk of fraud in the acquisition and expenditure cycle, auditors can use several types of searches and matches using CAATs.
      • Inspect invoices in files for photocopies.
      • Inspect vendor invoices submitted in numerical order.
      • Inspect vendor invoices that are always in round numbers.
      • Scan vendor invoices for invoices always slightly lower than a review threshold.
      • Scan vendor invoices for vendors with only post office box addresses.
      • Scan vendor invoices for invoices with no listed telephone number.
      • Match vendor and employee addresses and telephone numbers.
      • Scan multiple vendors at the same address and telephone number.
      • Vouch a sample of vendor invoices against the approved vendor list.
      • Review invoices for addresses of local mail drops.

    Inherent Risks in the Payroll Cycle

    • Ghost employees.
    • Overpaying (padding) for time or production.
    • Incorrect accounting (classification).
    • Failure to pay third-parties (e.g., payroll taxes, insurance).

    Payroll Activities

    • Personnel authorization forms are used to authorize all payroll-related transactions.
    • Employees record their hours worked using time sheets.
    • Supervisory personnel review time sheets and verify the distribution of hours worked on various jobs.
    • The payroll department processes payroll, preparing a payroll register and payroll checks.

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Related Documents

    Fraud Risk Assessment PDF

    Description

    Explore the complexities of fraud risks in financial statements through this comprehensive quiz. Understand management's potential for misleading practices, the phases of misappropriation of assets, and important fraud risk assessment considerations. Dive deep into the fraud triangle and evaluate critical factors that could lead to financial misconduct.

    More Like This

    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser