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Transcript of Audit
Jeanette Siah Ying Zhen
Lee Huey Chin
Are auditors sensitive
enough to fraud?
- Auditors are to do everything possible to prevent material financial statement fraud.
At the same time,
- Auditing is a competitive business subjected to demands for profitability and returns on capital.
- This creates a conflict by constraining
their ability to detect fraud.
1. There is an increased institutional stock ownership of companies.
2. Pressure is exacerbated due to substantial insider stock ownership or executive compensation tied to stock market performance.
Pressures for fraudulent financial reporting
- The case study used described a medium size manufacturing company in the semiconductor industry, along with a summary of the company’s past financial performance, an outlook for the company’s future, and the future of the industry and the economy.
- Senior auditors were asked to assess and indicate the changes, if any, in the analytical review procedures and tests of balances and details as applied to an audit of the inventory and production cycle for a case study.
Conduct of the study
The results of the study indicate the following four points:
1.All auditors increased the performance of certain procedures.
2.Some auditors chose not to reduce any procedures.
3.A consensus existed on which procedures to increase both for the analytical review procedures and tests of balances and details.
4.There was less agreement on which procedures to reduce for those auditors who chose to reduce some procedures. This was the case for both the analytical review procedures and tests of balances and details.
– Fraud causes negative financial impact, leading to confidence crisis over credibility of financial reporting.
- Reinforces the role of auditors to reduce information risk associated with financial information.
Detection of fraud is important because:
1. Fraudulent financial reporting
2. Misappropriation of assets
There are two types of fraud:
- Made up the prices of long-term futures contracts and recognized fictitious gains.
- More than half of their $1.41 billion reported pretax income for the year 2000.
Case Study #1
-Created imaginary sales and other revenues
i.e did not record write-down of assets acquired for expansion of their drug store chain that did not work out.
- inflate dollar value of damaged and outdated goods to receive larger credit from vendors.
- resulted in a $1.6 billion restatement of net income for the late 1990s (one of the largest corporate earnings restatement ever!).
Case Study #2
(Barrett, 1992; Kilman, 2002)
Firms intentionally take actions to overstate assets and revenues and understate liabilities and expenses.
Assets are being stolen from the company.
-Provide short-term returns to compete for investors' funds
-Expect short-term returns
-Pressured to report higher short-term returns
Table I shows a clear preference for two analytical review procedures: first, the further investigation of unusual fluctuations, and second, comparison of inventory turnover and number of days’ sales in ending inventory.
- Table II presents the number of auditors and their planned increase and decrease of the tests of balances and details procedures.
- The auditors seemed to agree that more work should be placed first, in testing for slow moving items, and second, comparing carrying cost to market values.
- Conversely, auditors exhibit less of a consensus regarding the performance of a specific procedure.
- Auditors emphases effectiveness over efficiency.
- Auditors perform additional work to “cover all the bases” to try increasing the effectiveness of an audit and reduce the potential for material misstatement.
- Auditors are taught to be risk averse and, consequently, trained more to reduce audit risk than to conduct an efficient audit.
- Auditor subjects almost seemed programmed to do more, not less.
- Fixed fee environment limits the amount of work that auditors are inclined to do.
- Thus, auditors no longer can sustain profitability by doing more work. Instead, the fixed fee environment requires auditors to “audit smarter”.
- “Auditing smarter” means that auditors have to achieve a greater balance between effectiveness and efficiency, by:
(a) Having a greater awareness of the context in which the audit takes place
- Financial statement fraud is concentrated in selective industries.
- The nature of financial fraud differs by industry.
- Level of corporate governance in the company have been linked to financial statement fraud.
(b) Understanding more of the relationship of audit procedures to the different audit objectives and the greater likelihood of certain accounting fraud in specific industries.
- Issuing more explicit auditing standards.
- Additional training to pay more attention to a company’s industry and its corporate governance structure.
Auditors need to be:
(a) more skeptical of management representations and more aggressive in assessing integrity of top management.
(b) sensitive to the conditions under which fraudulent financial reporting may flourish.
(c) effective in recognizing the occurrence of those conditions.
(d) attuned to the financial constraints under which they operate.