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Assignment 5: Capstone Research Project Sabrina Walker

Professor Achilles ACC 499: Undergraduate Accounting Capstone September 5, 2011

Leases on technology assets seem inflated. Under both US GAAP, revenue is not recognized until it is both realized (or realizable) and earned. FASB requires lessees and lessors to disclosure certain information about leases in their financial statements or in the notes. These requirements vary based upon the type of lease and whether the issuer is the lessor or lessee (Kieso, Weygandt, & Warfield, 2007). These disclosure requirements provide investors with the following information: General description of the nature of leasing arrangement The nature, timing, and amount of cash inflows and outflows associated with leases, including payments to be paid or received for each of the five succeeding years. y The amount of lease revenue and expenses reported in the income statement each period. y Description and amounts of leased assets by major balance sheet classifications and related liabilities. y Amounts receivable and unearned revenues under lease agreements (Kieso, Weygandt, & Warfield, 2007). The portion of the monthly payments related to future maintenance, service and supplies should be recognized as revenue later, when the services are actually provided. Revenue from the lease should be recognized immediately upon delivery of the equipment and interest cost should be recognized over the lease period. The consequences to the fraudulent activities include that the revenue will be overstated on the financial statement and the company could face charges from the Securities and Exchange Commission for inappropriately allocating lease receipts, which affects the timing of income that it reports. If it was to be done according to SEC guidelines, it would report income in different time periods (Kieso, Weygandt, & Warfield, 2007).

y y

Red Flags can come from your customers, when they are asking questions regarding their bill or the equipment, especially if it is coming from a lot of customers. The people that are involved consist of management, board of directors, the banks, shareholders as well as the lessees. Recommended internal controls would include frequently conducting internal audits as well as ensuring there is a separation of duties. Understatement of e-Commerce state tax payments E-Commerce fraud is currently a significant problem, and its growing every day. In recent years, the technology revolution has provided perpetrators with new ways to commit and conceal fraud and to convert their ill-gotten gains (Strayer University, 2011). US GAAP require entities to account for both current tax effects and expected future tax consequences of events that have been recognized (that is, deferred taxes) using an asset and liability approach (Ernest & Young, 2010). Fraudulent activities within the organization would mean that the company is understating the income; therefore, not paying taxes on the true amount of earned income. Although fraud can occur in any environment, several aspects of e-business environments present unique risks. These characteristics of the Internet-driven economy create pressures and opportunities specific to e-commerce fraud. Just like other frauds, these new frauds are perpetrated when pressures, opportunities, and rationalizations come together. Many of the most serious e-commerce fraud risks are found within organizations. Once perpetrators are within firewalls and security checks, it can be much easier to infiltrate systems, steal money and information, and cause damage (Strayer University, 2011).

Preventing fraud in every business setting involves reducing or eliminating the elements that motivate fraud: pressure, opportunity, and rationalization. The lack of personal contact makes it hard to know what pressures exist or what rationalizations perpetrators are using. True security is found when algorithms and processes are made public and stand the test of time. One of the best ways to prevent fraud in e-business settings is to focus on reducing opportunities, usually through the implementation of appropriate internal controls. In traditional businesses, internal controls involve five different elements: (1) the control environment, (2) risk assessment, (3) control activities or procedures, (4) information and communication, and (5) monitoring. The essence of effectively controlled organizations lie in the attitude of their management. If top management believes that control is important, others in an organization will respond conscientiously observing established controls (Strayer University, 2011). Fraud can also be prevented through control activities such as adequate separation of duties, proper authorization of transactions and activities, adequate documents and records, physical control over assets and records, and independent checks on performance, but often in ebusinesses they are not effective (Strayer University, 2011). Fictitious employees receiving post-employment benefits Under GAAP, the periodic postretirement benefit cost under defined contribution plans is based on the contribution due from the employer in each period. The defined benefit obligation is the present value of benefits that have accrued to employees through services rendered to that date, based on actuarial methods of calculation. The rule was not sufficient because they were able create fictitious employees to pay post-employment benefits. The consequences for this fraudulent activity lead the company to

lose a lot of money. Payment records should be compared to human resources files periodically to verify that a person is still employed within the company.

Red Flags for fictitious employees would focus on these items:

y y

High withholding exemptions or no withholding for income taxes No voluntary deductions for health insurance, retirement, or other normal deductions for the employee population

y y y y

No vacation, sick, or personal time charges No salary adjustments, merit adjustments, or promotions Duplicate bank account numbers Matching to other logical databases, e.g., security access, computer security access file or company telephone records

Fictitious employees tend to occur in departments where they would not be evident, and the local manager has a high degree of control over the hiring process. Audit Strategies for fictitious employees could include the following for each person, meet the individual and inspect a government-issued identification and search for evidence of work performance. This may be as simple as inspecting employees work area (Audit Strategy for Payroll Fraud, 2010).

Persons involved in this situation can include payroll manager, human resources department as well as the employee that is receiving the payments. Because these payments are taxdeductible, these payments affect the company as a whole, the contributions that have been made to these fictitious employees, were part of payments that received tax benefits. Taxes will have to be paid on these payments.

Concealing inventory shrinkage Concealing inventory shrinkage because it seems low for the industry implies that a company is not reporting the correct numbers. Because most companies in their industry have higher shrinkage numbers, they wanted to stay within the norm to avoid sending up red flags. But what they have done was subjected themselves to inventory fraud rather than reporting the truth. Reporting the actual shrinkage would have proven that they had good inventory control methods in place which could have been an example for the other companies in their industry. According to experts, inventory is the most common area for financial statement fraud. It is the easiest type of fraud to perpetuate and the hardest for even outside auditors to detect (Wiersema, 2001).Overstating inventory increases the companys bottom line dollar for dollar. The reason is that whatever winds up in ending inventory is not a cost against income this period. The cost is deferred until the indefinite future, which causes a corresponding loss the next year, unless the overstatement continues. Most managers who have engaged in inventory fraud experience it as an addiction. The amount of fraud continues to increase for the additional benefits it gives (Wiersema, 2001). Cost of Goods Sold (COGs) would be overstated as well, resulting in your net income being overstated, which could possible increase your tax liability. Inventory Control is the procurement, care and disposition of materials. There are three kinds of inventory that are of concern to managers: raw materials, in-process or semi-finished goods, and finished goods. If a manager effectively controls these three types of inventory, capital can be released that may be tied up in unnecessary inventory, production control can be improved and can protect against obsolescence, deterioration and/or theft (Inventory Control, 2002).

Trying to protect your company form the inside is different. Ultimately, protecting your company depends on having adequate accounting controls that go beyond physical safeguards. It is important to ensure you have an adequate internal control system in place according to your needs. For quantities, there is no substitute for accurate perpetual records that account for every transaction. It essential that the records leave a permanent audit trail, so they cannot be altered after the fact, this leaves out many of the cheaper software packages (Wiersema, 2001). Company executives realize that effective inventory management may be the difference between operating success and failure. To enhance inventory management, Wal-Mart has implemented radio frequency identification (RFID), a scanning technology similar to bar codes that allows inventory to be tracked from the supplier to the final consumer, and promises dramatic reductions in inventory costs (Strayer University, 2011). If there is any incentive pay that is tied to production levels, this could lead to inventory fraud. Workers are eager for the extra money and collude to over-report production, which can only be detected by taking an independent physical count (Wiersema, 2001). This process can be very costly and time consuming for a small business. Similarly, an inflated inventory value can lead to higher earnings, which, in turn, generate higher staff bonuses. Or, the overstated value can hide substantial shortages arising from theft against the company. These are going to be areas of concerns that will need to be monitored closely (Wiersema, 2001).

Reference List
Inventory Control. (2002, June). Retrieved August 20, 2011, from SCORE - Counselors to America's Small Business: Audit Strategy for Payroll Fraud. (2010, March 6). Retrieved September 2, 2011, from AFT: Accounting Financial Tax: Ernest & Young. (2010, March). US GAAP vs. IFRS: the basics, March 2010. Retrieved August 30, 2011, from Ernest & Young: $FILE/IFRS_vs_US_GAAP_Basics_March_2010.pdf Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2007). Intermediate Accounting, 12th Ed. Wiley. Strayer University. (2011). ACC 499: Accounting undergraduate capstone. Mason, OH: Cengage Learning. Wiersema, W. H. (2001, April). What managers need to know about inventory fraud. Retrieved August 20, 2011, from BNET: The CBS Interactive Business Network: