GAAP Rules for Determination of Fraud - Research Paper Example

? Capstone Research Project GAAP Rules for Determination of Fraud During the month of February, 1997, the ment in Auditing Standards (SAS) No. 82, Consideration of Fraud in a Financial Statement Audit was issued by the American Institute of Certified Public Accountants (AICPA) Auditing Standards Board (ASB). The rules determined within the SAS No. 82 precisely explain the responsibility of an auditor towards detection of fraud. Under this rule, the characteristics of fraud are properly explained and this helps the auditor to reach to a level of reasonable assurance that misstatements have been identified. The foremost factor that has to be understood before representing the misstatement as a fraud is the ‘nature of misstatement’. Nature represents as to whether the misstatement has been made intentionally or unintentionally. According to the specifications within SAS No. 82, fraud is an action that is conducted intentionally and as a result of which ‘material misstatements’ occur within a firm’s financial statements (American Institute of CPAs, 2011). There are several indicators of fraud that have been represented within the SAS No. 82. These are also considered as factors of risk, few of which have been listed below. The consideration of these cases will definitely help in identifying fraud in the given five scenarios within the case. Indicators of Fraud in Relation to Financial Reporting: (a) A massive amount of compensation for the management has been stated to be in structure of bonuses. (b) The management of the firm is dominated by an only individual or a very small group without allowing any role of the board of directors. (c) Involving into regular disputes with the present or previous management or auditors on issues related to auditing and accounting. (d) Limitations imposed on the auditor for improperly restricting activities related to key information and people. (e) Failure to pay the bills while there is reportedly huge earnings. (f) Transactions within related party apart from the normal courses of business. Indicators of Fraud in Relation to Assets Misappropriation: (a) Inadequacy of management supervision (b) Massive amount of cash is in hand or are processed on a regular basis (c) Inappropriate screening of the applicants for job (d) Inappropriate activities of record keeping (e) Inappropriate isolation of duties (f) Inappropriate process of approval of transactions (g) Non compliance with the time limit for presenting documents related to transaction (h) Inadequacy in controlling physical assets (i) Inappropriate provision of compulsory vacations for the employees (Porter & Pope, 2011). The fraud indications described under SAS No. 82 can well be compared with that of the given company for identifying whether fraud is taking place or not. If it is found that the management is guilty of the above fraud indications, the SAS specifications provide that the auditor can undertake the following activities: (1) Acquire a clear and concise understanding of the accounting process being carried out within the company along with verification of journal entries along with adjustments. (2) Categorize and choose particular journal entries along with adjustments for verifying. (3) Decide on the verification timing. (4) Investigate the individuals associated with activities in relation to financial reporting and make inquiries regarding lack of appropriation in journal entries as well as adjustments. (Public Company Accounting Oversight Board, 2011). Effectiveness of SAS No. 82 towards Minimization of Organization’s Fraudulent Activities After the incorporation of the standards under SAS No. 82, the various companies have started evaluating the impact of the rules to reduce frauds within the organizations. An internal analyst of financial activities can become successful through following the rules mentioned under SAS No. 82. However, there is requirement through the rules that the assessment of risk has to be conducted by an external auditor (Public Oversight Board, 2003). The auditors are vested with the entire responsibility of identifying risk of fraud for an organization. A few of the indicators that provide warning of frauds might not be comprehensively possible for the auditors to identify. For example, the auditors might not be able to oversee whether the organization’s management is continuously having meeting with related parties apart from the ordinary business deals. A number of factors mentioned within the SAS No. 82 are rather difficult to evaluate. For instance, there are certain factors that require understanding of the management characteristics and also impact of the managerial power within the internal business environment. Propensity of assets to theft is also at times required to be assessed for identifying risk related to asset misappropriation. The assessment of risk for fraud appropriately becomes difficult because at times there may be prevalence of factors of risk whereas fraud might not be susceptible to be prevailing. Even when there is existence of risk, the standards within SAS No. 82 do not provide specifications for the auditors to respond towards them. Thus, there are lots of loopholes within the standards that make the entire process vulnerable to be considered as disadvantageous for the organizations. To this note, it can be mentioned, according to personal judgment that the effectiveness of the rules under SAS No. 82 towards minimization of fraud is doubtful. Consequences of Fraudulent Activities to Organizations The consequence of fraudulent activities related to financial reporting is often violent for organizations. This is because continuous fraud can, at times, lead to insolvency, ownership changes and even de-listing of the involved company by the national stock exchanges. In addition to these consequences, the company can even be charged with high penalties. Along with the adverse consequences of fraud for the companies, the individuals involved in the fraudulent activities are also impacted badly. For instance, a senior executive of a company who is involved in fraudulent financial reporting process can be subjected to actions of the Securities & Exchange Commission (SEC) and also various other legal suits. As a result of allegations against the senior executive, he might be asked to pay huge penalties in monetary form in personal. After the identification of involvement of the senior executive personnel in fraud activities, the members can be forcefully induced to resign from their jobs. If the executives deny in resigning, the organizations hold sole discretionary powers to terminate him or her. In case of excessive involvement from the individuals upon fraudulent financial reporting, they might even be sentenced towards prison (Committee of Sponsoring Organizations of the Treadway Commission, 2011). Recommendations to Correction of the Red Flags The five red flags provided in the paper guidelines can be corrected through following various ethical auditing processes and financial reviews. A few of those processes have been mentioned below: Annual Auditing: It can prove to be a good and effective initiative to undertake annual audit for reviewing the statements of technology assets’ leasing. The hidden costs can also be reviewed that are held by the organization for future concealing of below-standard financial performance. The duty of auditing accurately can be provided to such a person who is not involved within the daily operations of the business. This should be done to incorporate a ‘bird’s eye view’ over the activities. The audit process should be effective because this would pressurize the staffs, conducting bookkeeping activities, to be honest. The auditor should keep on cross-questioning these staffs on any red flag issue in order to pressurize (CBIA News, 2007). Certified Public Accountant (CPA): If the owner is not in a position to regularly review financial operations, then he or she should make it clear that a CPA is appointed for this purpose. The CPA should be assigned the task of either taking up certain financial reviews independently or endow with each of the activities related to bookkeeping. This should assist in correcting the understatement of the e-commerce state tax payments and also concealing of low inventory holding. He should also be provided with assistants who can help him to overview physical movements of inventory. For making the process effective, the appointed CPA can conduct monthly review of the results with the past trends through discussion with the owner so that trends can be evaluated for identification of fraudulent practices (CBIA News, 2007). Protection of Payroll: The owners along with the managers should take up the extra hurdle of reviewing every payroll in person. This way the red flag, due to existence of fictitious employees receiving post employment benefits, can be corrected. This would bar the personnel involved in managing payroll from incorporating fraud activities. Apart from the managerial review, the assignment of job profile should be tactfully handled. For example, the person who holds the custody for checks should never be assigned the authority of signing the checks (CBIA News, 2007). Recommendations of Internal Controls to Prevent Reoccurrence of the Red Flags Among the various measures that the organization can take for preventing future reoccurrence of the five red flags, the following three have been recommended: Assignment of Appropriate Authority and Responsibility The management team should be highly concerned about not only selection of highly qualified and principled employees but also placement of these employees in the right situation. The sense of right situation is that the employees are not required to undergo unethical conduct due to environmental pressure. The hired employees should be assigned with precise job description and objectives of performance activities. Cooperation among the management team and the hired employees is, however, essential in this regard (Association of Certified Fraud Examiners, 2011). Provision of Compulsory Ethics Training All employees irrespective of the personnel’s level should be informed that undergoing of ethical training is of prime importance within the organization. The programs within the ethical training schedule must have to be inclusive of the tactics required for identification and eradication of fraud. The training program should also contain the organizational bearing towards corporate conformity, the organizational code of conduct towards ethics, events and standards of the organization. Apart from these, the program should also incorporate practices for making it clear that it must be the responsibility of the employees to report any identified instances of misconduct within the organization (Association of Certified Fraud Examiners, 2011). Implementation of Effective Measures towards Discipline Consistent measures for maintaining discipline for operational violations to ethical practices should be implemented for ensuring future occurrences of the red flags. There should be precisely explained sets of endorsements for those who violate ethical practices. Above all, the sets of measures should be the same for every personnel within the organizations. This has to be incorporated for the safeguarding of moral beliefs among all the employees of the organizations. There should be standards for punishing the employees who violate ethical values and similarly, there has to be rewards for those who depict ethical conducts. This is essential for the reinforcement of organizational ethical values among each and every employee of the organization (Association of Certified Fraud Examiners, 2011). References American Institute of CPAs. (2011). AU Section 316 Consideration of Fraud in a Financial Statement Audit. Retrieved September 03, 2011, from http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00316.pdf Association of Certified Fraud Examiners. (2011). How Management can Prevent Fraud in the Workplace. Retrieved September 03, 2011, from http://www.acfe.com/documents/tone-at-the-top-research.pdf CBIA News. (2007). Nine Ways to Prevent Fraud in Your Workplace. Retrieved September 03, 2011, from http://www.cbia.com/cbianews/2007/05/200705SB_PreventFraud.htm Committee of Sponsoring Organizations of the Treadway Commission. (2011). Fraudulent Financial Reporting: 1987-1997 — An Analysis of U.S. Public Companies. Retrieved September 03, 2011, from http://www.coso.org/FFR-Analysis_Summary.htm Porter, G. A. & Pope, M. (2011). The Auditor’s Consideration of Fraud in a Financial Statement Audit. Retrieved September 03, 2011, from http://www.porterandcompany.com/Articles/AuditorsConsideration-FraudAudit.pdf Public Oversight Board. (2003). Earnings Management and Fraud. Retrieved September 03, 2011, from http://www.pobauditpanel.org/downloads/chapter3.pdf Public Company Accounting Oversight Board. (2011). AU Section 316 Consideration of Fraud in a Financial Statement Audit. Retrieved September 03, 2011, from http://pcaobus.org/Standards/Auditing/Pages/AU316.aspx Read More