Essay Sample on Auditing Fraud: Meeting the Challenge Through External Audit

Published: 2019-11-04
Essay Sample on Auditing Fraud: Meeting the Challenge Through External Audit
Type of paper:  Essay
Categories:  Management Finance Audit Financial management
Pages: 7
Wordcount: 1678 words
14 min read

Fraud refers to a manager's, or a firm's misconduct action, that results in material value loss to shareholders that may trigger legal enforcements (Turner Eric, CPA, 2013).

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Audit quality is progressively much in the spotlight as the main element of financial reporting development. Through effective supervision of the task of the external auditor, audit committees also can contribute to the audits general quality whereas conserving the external auditors sovereignty. Chartered Professional Accountants of Canada (CPA Canada), the Canadian Public Accountability Board (CPAB), and the Institute of Corporate Directors (ICD) are teaming up to develop guidance and equipment to assist audit committees practice their supervision activities in manners that consistently augment audit quality (Turner Eric, CPA, 2013).

This publication summarizes particular responsibilities of audit committees of Canadian reporting auditors and the actions that facilitate audit committees meet responsibilities. This guideline also presents how corporations get away with overestimating or underestimating accounts in their financial statements, periodically, even with an external audit (Smieliauskas, et al 2012). The various types of challenges that external auditors do encounter when dealing with internal auditors at corporations found to practice fraudulent activities, the consequences such fraudulent corporations face, once revealed, and the importance of the findings of the external audit in uncovering these corporations.

Concerns have risen about familiarity and self-interest coercion between external auditors and the firms they audit at the institutional echelon. Such threats have are referred to as institutional familiarity threats (Silverstone, et al, 2005)

Present perception is that, after an extensive period of time, the interaction between external auditors and their respective clients become too close. This may create a threat to self-determination that impedes the capacity of the external auditor and particularly the engagement team members from implementing appropriate proficient skepticism (Smieliauskas, et al 2012).

The Enhancing Audit Quality (EAQ) initiative, a cooperative project of CPA Canada and CPAB, studied how to facilitate audit quality in light of comprehensive developments. The program considered diverse alternatives for protection against institutional acquaintance pressure, ranging from subjugating external auditors to periodic limits to calling for obligatory tendering of audits (Turner Eric, CPA, 2013).The enterprises report Enhancing Audit Quality: Canadian perspectives terminates that the alternative majorly to develop audit quality is the role of audit committees to conduct an all-inclusive review of the external auditor at least in every five years. Such an inclusive review is well considered-out to be in the best significance of stakeholders, as disparate to a one size fits all obligation that does not take into account the particular state of affairs of the entity and its shareholders (Silverstone, et al, 2005).


Inventory Manipulation

Fraud against a production includes the stealing of physical assets that consist of cash or inventory. The pilfering of inventory is normally perpetrated by a member of staff and can be discovered relatively quickly in an atmosphere where there are sturdy internal regulations. There are fundamentally two cases of inventory fraud: actual corporeal loss and financial statement fraud.

Financial Fraud

Financial statement fraud is purposeful misrepresentation, misstatement or exclusion of financial statement figures for the purpose of deception to the stakeholder and generating a false intuition of an organization's financial potency (Turner Eric, CPA, 2013).

Inventory fraud can be dedicated through financial statement exploitation. These include timing schemes, operating cost recorded as supply, and valuation scheme. This form of fraud is usually put into practice by senior management and is aggravated by the need to achieve some financial goal or yardstick. Inventory overstatement is the mainly common type of account related fraud. Management may be goaded to report elevated earnings to either to satisfy stockholders, attain compensation targets, or uphold bank lending contracts .One approach to inflate revenue is to overstate inventory (Smieliauskas, et al 2012).

This is the type of fraud in several of the very famous and considerable public company frauds in current history. Cost of Goods sold is premeditated by subtracting the raise in inventory from purchases. For that reason, overstating final inventory, increase in inventory understates cost of merchandise sold and has the outcome of reporting higher earnings.

On the other hand, management is now and then motivated to report inferior profit in order to frontier the quantity of taxes. This is predominantly prevalent in diminutive closely-held businesses. For instance, understating inventory brings about the overstatement of outlay of goods sold and, as a result, the overall net income.

It is not extraordinary to find that a production is the victim of both types of fraud, both theft and financial statement fraud (Smieliauskas, et al 2012), that occur simultaneously since the incidence of either designate lax internal controls.

Even if inventory is being stolen or the pecuniary statements are being fabricated for some reason, there are a number of warning signs that point out that there may be a predicament. These include:

The inventory asset worth does not change for quite a few periods, or the change is nominal

The gross profit entitlement never revolutionize from period to period

Inventory values are ever-increasing at a faster velocity than sales

Remarkable changes to the inventory earnings ratios

Shipping costs as a proportion of inventory changing considerably

Low inventory estimation even though the storehouse is full of inventory

High inventory appraisal even when the warehouse is unfilled

Shipping proof of purchases that cannot be outlined to purchases or sales

Average costs per unit fluctuate widely from authentic costs per unit for an unlimited period of time

Inventory counts contrast widely from quantities recorded in the continuous inventory system

Shipping bills of lading with strange or unconstitutional delivery addresses

Fictitious Revenues

This can engross fake or ghost customers. The scheme involves by means of various accounts. Since preset assets and revenues typically are noteworthy, amounts these fabricated revenues will go unnoticed dissimilar to cash and accounts receivable (Silverstone, et al, 2005). Supplementary involved systems would be to utilize legitimate customers and blow up or alter bill of lading to reflect higher than concrete amounts (Smieliauskas, et al 2012). Another outward appearance of conjured revenues involves sales with circumstances or terms than havent been completed and privileges of risk of possession have not passed to the customer. These are not sales according to commonly accepted accounting philosophies.

Timing Differences

Intentional recording of revenues or costs in inappropriate periods is another structure of financial statement fraud. This results in mounting or decreasing revenues as desired in definite periods. One of the considerable abuses over the years has involved acquiescence with accounting regulations over revenue acknowledgment.

Persuasive Evidence of Arrangement; the following specify non-existence)

No written or spoken arrangement exists ,written is ideal and customary

A written order is unconfirmed upon sale to end users or contain a right of return

A side letter modifies the terms of a printed agreement and eliminates the required elements of a conformity

Delivery has not occurred or services have not been rendered

There has not been a consignment and the acceptable exceptions such as bill and hold dealings have not met the apposite criteria set out.

There has been a delivery but has been shipped to the sellers mediator, other delegate or to a public stockroom or not the entire components requisite for business was shipped.

Some components essential for operation were not delivered or items of erroneous specification were shipped.

Consignment delivery is not well thought-out complete until setting up, customer testing and purchaser acceptance has occurred (Silverstone, et al, 2005). For any non-standard item for consumption or service custom-made to buyer specifications, confirmation of client acceptance is vital, and regularly contractually driven in determining revenue appreciation.

Another standard decisive factor for recognizing revenue is based on title transitory during delivery. Enticing side agreements can contaminate the delivery and title progression, creating a consignment state of affairs by offering to the purchaser, who has accepted title on deliverance risk free, and interest-free purchasing or repurchase clauses at fundamentally the same price. In such cases, returns ought not to be recognized awaiting a third party sale, regardless of title passing (Turner Eric, CPA, 2013).Other revenues, like activation fee, cannot be renowned as revenue independently and need be amortized over the period of the overhaul provided. A buyer does not go to a product or service provider and signal up for the setup exclusive of getting the ordinary service. They are not separate procedures.

Concealed Liabilities and Expenses

Understating liabilities and costs is one way monetary statements make a Company materialize to be more profitable. Omitted transactions can be hard to detect than reprehensively recorded transactions, given that the unrecorded transactions disappear without recorded audit trail (Smieliauskas, et al 2012).

The following are three ordinary ways for obscuring liabilities and expenses:

Accountability/expense omissions

Capitalized expenses

Failure to unveil warranty costs and liabilities


Financial statement clients and managers do expect external auditors to perceive fraudulent financial reporting. Detecting fraud is the accountability of external auditors and consequently they ought to uncover it. Audit regulators and the audit profession have responded to such expectation by issuing various standards that outline auditors roles in detecting fraudulent activities (Smieliauskas, et al 2012). Such standards stipulate that auditors have the responsibility to provide reasonable assurance that audited fiscal statements are free of material misstatements arising from fraud. Fraud examiners and regulators specialize in inspecting actual or suspected fraud cases then present their results in various fora, comprising litigation settings.

Contemporary auditing standards impose a positive responsibility on auditors to obtain reasonable assurance that financial statements are free of material fraud, whether due to misappropriation of assets or fraudulent financial reporting (Turner Eric, CPA, 2013). These principles recognize the presence of unavoidable risks which other material fraud might no longer detect although the audit is appropriately strategized and performed in conformity with their guidance and perceptions. The relevant objectives that auditors need consider in assessing fraud in financial statement include;

Identifying and assessing fraud risk.

Obtaining sufficient appropriate material regarding the examined fraud risk via designing and implementing suitable response.

Responding suitably to fraud or suspected fraudulent activity in the process of audit.

In order to meet such objectives, audit...

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