Workshop Week 7

Q9.23

INFORMATION FRAUD CONDITION

1. Management has a strong interest in

employing inappropriate means to minimise
Incentives/pressures
reported earnings for tax-motivated reasons.
2. Assets and revenues are based on significant
Opportunities
estimates that involve subjective judgments
and uncertainties that are hard to corroborate.

3. The company is marginally able to meet

Incentives/pressures
exchange listing and debt covenant
requirements.
4. Significant operations are located and
Opportunities
conducted across international borders in
jurisdictions where differing business
environments and cultures exist.
5. There are recurring attempts by management
Attitudes/rationalisation
to justify marginal or inappropriate accounting
on the basis of materiality.
6. The company’s financial performance is
Incentives/pressures
threatened by a high degree of competition
and market saturation.

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How can ratio analysis be used to detect revenue-related fraud?

Ratio Calculation Indications?

Gross Profit (Margin) Gross profit / Net sales Effect of – overstating sales,
Ratio fictitious sales, understating
sales returns, understating
sales discounts, early
recognition of sales? Ratio
increased.

Sales Return Percentage Sales returns / Total sales Effect of understating sales
returns? Ratio decreased.

Sales Discount Percentage Sales discounts / Total sales Effect of understating sales
discounts? Ratio decreased.

Accounts Receivable Sales / Average net accounts Effect of overstating sales?

Turnover receivable Same amount to both
numerator and denominator –
turnover increased if sales >
AR.

Days in Receivables 365 / Accounts receivable turnover Effect of overstating sales?

Generally expect days to
increase because fictitious
sales will not be collected.

Provision for Doubtful Provision for doubtful debts / Effect of understating

Debts % of Receivables Accounts receivable provision? Ratio decreased.

What is the effect of overstating inventory on cost of sales?

Period 1 – overstated Period 2

inventory
Beginning inventory None Overstated

+ Purchases None None

- Purchases returns None None

- Purchases discounts None None

Goods available for sales None Overstated

- Ending inventory Overstated None

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Cost of sales Understated Overstated

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What is the effect of overstating inventory on the income statement?

Income Statement Effect of overstating inventory?

Sales None
- Sales returns None

- Sales discounts None

Net sales None

- Cost of sales Understated

Gross margin Overstated

- Expenses None
Profit Overstated

How can ratio analysis be used to detect inventory-related fraud?

Ratio Calculation Indications?

Gross Profit (Margin) Gross profit / Net sales Effect of overstating
Ratio inventory? Cost of sales
understated. Ratio increased.

Inventory Turnover Cost of sales / Average inventory Effect of overstating

inventory? Cost of sales
understated. Inventory
overstated. Ratio decreased.

Days Sales in Inventory 365 / Inventory turnover Effect of overstating

inventory? Ratio increased.

How can ratio analysis be used to detect liability-related fraud?

Ratio Calculation Indications?

Current Ratio Current assets / Current liabilities Effect of understating accounts

payable? Ratio increased.

Quick Ratio Quick assets / Current liabilities Effect of understating accounts

(Current assets less inventory) payable? Ratio increased.

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 Accounts Payable to Accounts payable / Total liabilities Effect of understating accounts
Liabilities payable? Ratio decreased.

Accounts Payable to Accounts payable / Inventory Effect of understating accounts

Inventory payable? Ratio decreased.

Accounts Payable to Cost Accounts payable / Cost of sales Effect of understating accounts
of Sales payable? Ratio decreased.

Warranty Expense to Sales Warranty expense / Sales Effect of understating warranty

expense? Ratio decreased.

Interest expense / Total liabilities Effect of understating interest

expense? Ratio decreased.
Debt / Total equity Effect of understating
Debt / Total assets liabilities? Ratio decreased.

How can ratio analysis be used to detect asset-related fraud?

Ratio Calculation Indications?

Non-current assets / Total assets Effect of overstating assets?
Ratio increased.

Individual non-current assets / Effect of overstating assets?

Total non-current assets Ratio increased.

Depreciation Expense to Depreciation expense / Total non- Effect of understating

Assets current assets (by category) depreciation? Ratio decreased.

Accumulated Depreciation Accumulated depreciation / Total Effect of understating

to Assets non-current assets (by category) depreciation? Ratio decreased.

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Q10.19

MISSTATEMENT a. b.

TRANSACTION- COMPUTER-BASED
RELATED AUDIT CONTROLS
OBJECTIVE

1. A customer order was filled  Recorded  Pre-processing

and shipped to a former transactions occurred authorisation
customer that had already  Pre-processing
gone into liquidation. review
 Programmed
controls (e.g.
comparison to
customer file)
2. The sales manager approved  Transactions are  Pre-processing
the price of goods ordered stated at the correct review
by a customer, but she amounts  Programmed
wrote down the wrong price. controls (e.g.
comparison to the
online authorised price
list)

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 MISSTATEMENT
3. Several remittance advices
were prepared ready for
data entry. The cash receipts
clerk stopped for coffee,
placed them on a box and
failed to deliver them to the
data entry personnel.
4. A customer number on a
sales invoice was transposed
and, as a result, charged to
the wrong customer. By the
time the error was found,
the original customer was no
longer in business.
5. A former computer operator,
who is now a programmer,
entered information for a
fictitious sales return and
ran it through the computer
system at night. When the
money came in, he took it
and deposited it in his own
account.
6. A computer operator picked
up a transaction file for sales
of the wrong week and
processed them through the
system a second time.
a. b.
TRANSACTION- COMPUTER-BASED
RELATED AUDIT CONTROLS
OBJECTIVE
 Existing transactions  Control totals
are recorded reconciled to manual
 Transactions are totals of all batches
recorded on the correct  Computer accounts
dates for numerical sequence
of batches submitted
 Recorded  Key verification
transactions occurred  Check digit
 Transactions are  Reconciliation to
properly posted and customer number on
summarised purchase order and
bill of lading
 Recorded  Input security
transactions occurred controls over cash
receipts records
 Scheduling of
computer processing
 Controls over
access to equipment
 Controls over
access to live
application programs
 Recorded  Correct file controls
transactions occurred  Cutoff procedures
 Transactions are  Programmed
recorded on the correct controls (e.g. check for
dates sequence of dates)
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 MISSTATEMENT a. b.

TRANSACTION- COMPUTER-BASED
RELATED AUDIT CONTROLS
OBJECTIVE

7. For a sale, a data entry  Existing transactions  Conversion

operator erroneously failed
to enter the information for
the sales representative’s
department. As a result, the
sales representative received
no commission for that sale.
are recorded verification (e.g. key
verification)
 Programmed
controls (e.g. check
field for completeness)

8. A non-existent part number  Existing transactions  Pre-processing

was included in the
description of goods on a
shipping document.
Therefore, no charge was
made for those goods.
are recorded review
 Programmed
controls (e.g. compare
part number to parts
list master file)

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Using Generalised Audit Software for Inventory.

You are a member of a team involved in the audit of inventories of ABC Distribution
Company. A computer-based inventory system is used by the company. You are provided
with two data files (in the Sample Data Files folder):

INVENT.FIL Inventory Master File as at December 31 2020.

STKTAKE.FIL Inventory Stocktake File as at December 31 2020.

STKTAKE.FIL will be used to update the master file and report necessary adjustments as at
December 31 2020. This means that stocktake figures will replace recorded quantities.
Adjustments to book values will be written off against profit.

You are to produce an audit memorandum to the partner-in-charge dealing with each of the
following issues.

1. Stocktake Results

(a) Details and values of products not counted.

(b) Significant adjustments, ie. adjustments (positive/negative) in excess of $150. (The
adjustment is calculated as BOOK – [COUNTQTY * AVCOST]).
(c) Total value of adjustments to inventory book value.

2. Potentially Obsolete Inventory

(a) Products selling below average cost.

(b) Products with zero selling prices.
(c) Products with excessive holdings (over 6 months sales).
(d) Products that have not moved in the past 6 months.
(e) Total value of potentially obsolete inventory (produce a consolidated report with no
duplicates indicating which of the above criteria were met for each product).

3. Valuation of Inventory

(a) Products where book value differs from book quantity on hand extended at average
cost.

4. Other Issues

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(a) A summary of the different product groups in terms of quantity on hand and book
values.
(b) The range of book values and the distribution of book values in the master file,
including the number of products falling into particular intervals (ie. Stratification).

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Output

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