CAF 8: Audit & Assurance

Suggested Solution – Test # 9 (Chapter 19)

Answer # 1

Sr. # Effect on Risk of Material Misstatement Fraud Risk Factor

1 Decrease No
2 Decrease No
3 Increase Yes
4 Increase Yes
5 Decrease No
6 Increase No
7 Increase Yes
8 Decrease No

Answer # 2

Fraud Risk factors include following:

1. Management is having trouble in understanding reports produced by new
accounting system. This will cause ineffective controls over the system.
2. Complains about credit controllers are also a fraud risk factor, which is further
increased by the fact that this managerial role has close association with those
charged with governance.
3. There is domination of management by finance director which creates risk of
fraud. Further, close association between finance director and chairman of board
of director also increases risk of fraud as audit committee lacks independence and
may not oversee management effectively.
4. Management’s refusal to sign written representation letter also raises concerns
about integrity of management and increases risk of fraud.

Notes for students: (not part of solution)

1. “Many of LED’s projects are complex” increases risk of material misstatement,
but not necessarily risk of fraud.
2. Engineers having shares does not increases risk because engineers have no
influence over financial statements.
3. Factors which reduces risk of fraud are:
 The company is in a sound financial position and has solid cash reserves.
 Management is reasonably vigilant in overseeing the accounting staff.

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 CAF 8: Audit & Assurance
Suggested Solution – Test # 9 (Chapter 19)

Answer # 3

Sr. Audit Implications

#
1 This is a control weakness. Individual has the ability to personally encash open
cheques received from debtors and conceal it by understating unpresented
cheques or overstating deposit in transit.
2. Pressure from stakeholders and contingent compensation are now a days
common in companies but their existence is a fraud risk factor for auditor.
3. Internal Audit’s independence is impaired, and its role will be less effective in
organization.
4. This is a fraudulent financial reporting. Auditor should perform procedures
advised by ISA – 240 in such situations.
5. Accountant behaved well till showing his concern. After that, he should have
informed either to internal auditor or external auditor. This shows ‘whistle-
blowing’ procedures are not implemented in the organization and indicates a
weak control environment.
6. This situation questions ‘auditability’ of client i.e. whether sufficient appropriate
audit evidence can be obtained. It also indicates fraud.

Answer # 4

Significant decline in customer demand:

Due to significant decline in demand of foreign customers, the management may be
inclined to show improved results by manipulating the accounting records.

Significant related party transactions:

Significant related party transactions between GL and BL would provide an opportunity
for engaging in fraudulent financial reporting.

Sale of shares by director:

The directors' intention to sell their shareholding in GL provides them an incentive to
manipulate the annual profits so that they can achieve the maximum possible gain from
the sale of shares.

Non-implementation of last year’s external auditor’s recommendations:

Management failure to place controls against weaknesses identified by the external
auditor on timely basis shows the management’s attitude towards the improvement of
internal controls and consequently it increases the risk of fraud.

(THE END)

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