10–11
10-26 (continued)
10-27 1. a. Fraud.
period. Confirm accounts receivable at year-end.
2. a. Error.
of a prenumbered bill of lading.
c. Trace credit entries in the perpetual inventory records to
receivable at year-end.
3. a. Fraud.
report, and invoice have been matched.
c. For a sample of cash disbursements, examine approval of
order, receiving report, and invoice.
4. a. Fraud.
b. Independent verification of packing slip.
records and investigate any shortages.
5. a. Fraud.
to all customers.
c. Trace from recorded sales transactions to cash receipts for
6. a. Error.
b. Internal verification of invoice preparation and posting by an
10–12
10-27 (continued)
7. a. Fraud.
b. The prelisting of cash receipts should be compared to the
postings in the accounts receivable master file and to the
10-28 a. The lack of separation of duties was the major weakness that
permitted the fraud for Appliance Repair and Service Company.
Gyders has responsibility for opening mail, prelisting cash, updating
b. There are several suggestions that could reduce the potential for
fraud at Appliances Repair and Service Company. Many of these
1. As soon as cash is received, a prelisting of cash should be
prepared. The purpose of a prelisting of cash is to
Furthermore, if a dispute arises with a customer, it is easy to
trace to the prelisting and determine when the cash was
or sales for credits, or adjust accounts receivable for sales
returns and allowances or bad debts.
2. Subsequent to the prelisting of cash, it is desirable for an
prelisting, or prepares or makes the deposit.
3. A general rule that should be followed for depositing cash is
that it should be deposited as quickly as possible after it is
received, and handled by as few people as possible. It is
10–13
10-28 (continued)
department who would subsequently compare the total to the
prelisting. When an independent person prepares the bank
reconciliation, there should also be a comparison of the
prelisting to the totals deposited in the bank.
10-29 a.
WEAKNESSES IN PROCESSES
LIKELY MISSTATEMENTS
1. The foreman has the ability to hire
employees and enter their names into
the pay system with no other approval.
Nonexistent or incompetent employees
may be hired at the foreman’s option.
2. The foreman may make changes to
salary rates without approval of
company management.
Employees may be paid at rates that
are higher than their skill warrants.
3. No investigation of new employees to
determine background experience and
dependability is performed.
Dishonest or unqualified employees
may be hired.
4. No control exists over time cards and
the completion thereof.
Employees may report and be paid for
time that they did not work.
5. No review or internal verification of the
amount on the payroll checks is
performed.
Misstatements made by the payroll
clerks in favor of employees would
likely not be discovered.
6. Payroll checks are not prenumbered or
controlled by the payroll clerks.
The chief accountant could prepare,
sign, and cash an extra payroll check
without detection.
payroll is less likely.
10–14
Copyright © 2017 Pearson Education, Inc.
10–30 The PCAOB has reorganized PCAOB auditing standards effective
December 31, 2016. The responses below reflect the location of the
appropriate guidance in the reorganized standards.
a. Guidance for auditor consideration of fraud in a financial statement
the following procedures:
1. The auditor may decide to observe inventory counts at certain
reporting period to minimize the risk of inappropriate
of the reporting period.
2. The auditor might perform additional procedures during the
labeled, and the quality (that is, purity, grade, or concentration)
3. The auditor might choose to conduct additional testing of count
alteration or inappropriate compilation.
4. The auditor may want to employ additional procedures directed
at the quantities included in the priced out inventories to further
test the reasonableness of the quantities counted and the
auditor may consider using computer-assisted audit techniques
duplication.
b. Paragraph .68 of AS 2110, Identifying and Assessing the Risk of
Material Misstatement, requires the auditor to presume that there is
10–15
10-30 (continued)
recognition:
1. Performing substantive analytical procedures relating to
revenue using disaggregated data to examine revenue by
the absence of side agreements.
3. Inquiring of the entity’s sales and marketing personnel or in–
house legal counsel regarding sales or shipments near the end
appropriate sales and inventory cutoff procedures.
5. For those situations for which revenue transactions are
electronically initiated, processed, and recorded, testing controls
1. The discussion among engagement personnel in planning the
audit regarding the susceptibility of the entity’s financial
statements to material misstatement due to fraud, including how
identify and assess the fraud risks.
3. The fraud risks that were identified at the financial statement
4. If the auditor has not identified, in a particular circumstance,
5. The results of the procedures performed to address the
10–16
10-30 (continued)
6. Other conditions and analytical relationships that caused the
conditions.
7. The nature of the communications about fraud made to
management, the audit committee, and others.
e. Paragraphs .54 through .58 of AS 12 require the auditor to make
inquiries of management, the audit committee, internal audit, and
other personnel about their views of the risks of material
The above guidance is contained in paragraphs .54 through
f. Paragraph .65 of AS 12 (which is now in paragraph .65 of AS
2110) defines “fraud risk factors” as “events or conditions that
indicate (1) an incentive or pressure to perpetrate fraud, (2) an
opportunity to carry out the fraud, or (3) an attitude or rationalization
that justifies the fraudulent action.” Fraud risk factors do not
necessarily indicate the existence of fraud; however, they often are
10-31 a. These procedures are examples of techniques auditors employ to
address the risk material misstatement due to fraud. Most of the
procedures are intended to directly address the risk of
management override of controls. Auditing standards require that
three types of procedures be performed in every audit to address
10-31 (continued)
b.
Procedure
Purpose
1.
The auditor is using audit software to facilitate the
examination of journal entries recorded in the various
accounting journals. The auditor is particularly
interested in examining large transactions (those
greater than $1 million) and those with unusual
account codings, to determine if any of these
transactions suggest the possibility of fraud, including
management override of controls to perpetrate fraud.
2.
The auditor is performing a “look back” evaluation of
the prior year allowance to determine whether there is
any evidence of bias in management’s prior year
estimation of potential uncollectible accounts. The
auditor is evaluating the extent to which current year
write-offs differed from management’s prior year
estimate to evaluate whether there is any evidence that
management might have intentionally understated or
overstated the allowance estimate.
3.
The auditor’s decision to examine inventories at two of
the smaller warehouses is an example of how the
auditor is including an element of unpredictability in the
audit strategy. Management might be familiar with
audit procedures used by the auditor in prior years and
thus embed a fraud in areas not typically examined by
the auditor. An element of unpredictability in the audit
strategy may deter management from such behavior.
4.
Auditing standards emphasize the importance of
understanding the underlying rationale for significant
unusual transactions that might be outside the normal
course of business for the company for purposes of
evaluating whether the transactions have been entered
into to engage in fraudulent financial reporting. In this
instance, the auditor is obtaining information to
understand the business rationale of this new joint
venture and to evaluate whether management may be
engaging in this new type of transaction to perpetrate
fraudulent financial reporting.
5.
Manual journal entries made by management outside
of the accounting information system provide an
opportunity to manipulate information outside internal
controls embedded in those systems. A number of
frauds have occurred through “top-side adjustments.”
whether any of the manual journal entries suggest the
presence of fraudulent financial reporting.
10–18
Copyright © 2017 Pearson Education, Inc.
10-32 a. The auditor must conduct the audit to detect errors and fraud,
including embezzlement, that are material to the financial statements.
It is more difficult to discover embezzlements than most types of
errors, but the auditor still has significant responsibility. In this
situation, the weaknesses in Bargon’s processes are such that
they should alert the auditor to the potential for fraud. On the other
hand, the fraud may be immaterial and therefore not be of major
concern. The auditor of a public company must also consider the
impact of noted deficiencies when issuing the auditor’s report on
internal control over financial reporting. When noted deficiencies
b. The following weaknesses in Bargon’s processes exist:
1. The person who reconciles the bank account does not
2. The president signs blank checks, thus providing no control
over expenditures.
cancelled when paid.
c. To uncover the fraud, the auditor could perform the following
procedures:
1. Comparison of payee on checks to cash disbursements
journal.
payee to cash disbursements journal.
10-33 1. a. Fraudulent financial reporting.
b. N/A
2. a. Fraudulent financial reporting.
b. N/A
3. a. Misappropriation of assets.
10–19
10-33 (continued)
4. a. Fraudulent financial reporting.
b. N/A
5. a. Misappropriation of assets.
6. a. Fraudulent financial reporting.
b. N/A
held for customers during inventory observation.
7. a. Fraudulent financial reporting.
b. N/A
c. Confirm accounts receivable at year end. Obtain last receiving
trace to credit memos.
8. a. Misappropriation of assets.
the cash register.
c. N/A
9. a. Fraudulent financial reporting.
b. N/A
c. Review supporting documentation, including purchase order,
10-34 1. a. There may be unrecorded cash disbursement transactions.
b. Because the transactions relate to cash disbursements, the
cash account will be affected. The accounts payable account
c. Existing transactions are recorded (completeness).
10–20
10-34 (continued)
in the master file.
b. Accounts receivable and sales are likely to be affected by
instead.
b. Repair and maintenance expenses and fixed assets are
likely to be affected.
c. All repair and maintenance expenditures that do not meet
4. a. Management may have manipulated key assumptions so
to be affected.
5. a. The client may have shipped and recorded large amounts
of goods close to year end to third parties who may hold the
b. Accounts receivable and sales and the related costs of
b. Accounts payable would be overstated and the related asset
c. Recorded amounts existed (occurrence).