Audit of VIS Company - Assignment Example

Name of the student: Course Tittle: Name of the professor: Date Investigation Report Introduction This paper presents discussion of an audit report of VIS Company and the fraudulent activities which has taken place within the company. It gives insights of various accounting principles (GAAP) and audit principles which apply in the analyzed case. Question one Generally accepted accounting principles (GAAP) are principles and guidelines in accounting which companies uses to measure the volume of their transactions with a sole purpose of measuring net income for the accounting period and to report financial position at the end of trading period (GAAP Pg.16). IAS 18 defines revenue as economic benefit inflow arising from business activities of a firm. GAAP on the other hand defines revenue as inflows or other enhancements of asset of a firm (GAAP Pg.32). Under sale of goods, GAAP states that revenue should not be recognized in the books of accounts until it is fully earned. SAB 104 gives conditions under which must be met for revenue to be recognized, they include; There must be a persuasive evidence of existing arrangements for payments Either services has been done or the delivery of goods has taken place The collectability of goods is beyond reasonable doubt has been assured Under service provision, The GAAP recognized the use of percentage of completion only if the company involve in a long term contract or project like road construction. The service provider should first determine whether the services they are a bout to deliver are within the scope of specific accounting literature which requires them to use percentage of completion method(GAAP Pg.52). In cases of revenue refund, the GAAP states that a right to refund may preclude revenue recognition from the service arrangement until the time when the righto refund has expired. Under contract project, GAAP requires that percentage of completion should be used though it is not a requirement and recommends completed contract method if the contractor can not accurately estimate the exact revenue and cost. It further clarifies that revenue should be recognized on the basis of increase in an entity net position in a contract with the customer (GAAP Pg.44). Question Two From the footnotes and the company treatments of the contract elements, the company is not following the Generally Accepted Accounting principles in revenue recognition. In recording one of the transactions relating to Penns Company, the revenue was recognized immediately though the actual payment had not occurred. This is not in accordance with GAAP which requires that revenue should only be recognized when it has been actually earned. On the same transaction when the invoice was reversed, it did not follow the GAAP in revising the transactions as the GAAP states that states that a right to refund may preclude revenue recognition from the service arrangement until the time when the righto refund has expired and in this case of Penns Company, it was done before thee expiry of 120 days meaning the accountant violated the principles of the International Accounting Standard Board and the GAAP. In Tempo Inc. transaction, the principle of revenue recognition was also not followed as the actual amount of the invoice value was not recognized in the income statements. If the contract was long term, they company accountant could have quoted the time period and the percentage of completion, but in this case, the contract was a simple delivery of services which ought to have been reported immediately after completion of the work. In reference to the revenue recognition invoice relating to service rendered to McDonald company, the transaction was recognized immediately though the payment had not taken place, in in this instances, the revenue recognition did not follow the GAAP conditions. The revenue recognition on the services rendered to the Nexus software also was recognized though it did not indicate the completion time and the amount of the work which was done by the company concerning software installation and other related services which was rendered to the company. This recognition format is not according to GAAP concerning revenue recognition. The revenue which relates to services rendered to Boeing Defense Services was recognized in full though its payment was recognized all at once violating the GAAP principle which states that revenue should be recognized only when it has actually earned. Question Three In recording the invoice of Penns Engineering service, there was overstatement of the actual amount to be paid, invoice number 31290 was recorded twice with the amount $75,000. This was overstatement since the actual payment was done on the invoice number 32150 on 5/14/2010 In payment to Tempo Inc. the invoice number 29934 was recorded at $ 45, 000, and invoice number 31065 was recorded at $ 23,000 so the total amount for the two invoices is supposed to be $ 68,000, payment was done in two phases where $ 25,000 was recorded against invoice No29934 and another cheque amounting to$ 43,000 recorded against the two cheques but the two cheques hence there was no overstatement in Tempo transaction. Other transactions as of December 31, 2009 were not overstated. As of December 31, 2010, the following overstatements were made on the account receivables; The account receivable by Nexus Software was overstated since the actual amount of the payment received by the company was only $ 15,000 and the reverse payment was $ 187,210 and the total amount reported was now amounting to $ 202,210. This was overstating the count receivable which is a fraud by itself. In billing CMI K/P Modules, the invoice was issued worth $ 197,697 which was recording by the company, the payment which was done was only $ 107, 697 and another invoice worth $ 90,000 was recorded and then reversed showing that there was overstatement. On the same amount, $ 1697 was also missing and could not be traced making the auditor to declare it immaterial further pointing out overstatements of the account receivable. The audit report further reveals that there was no actual payment by the creditors but this was a fictitious creditor hence overstatement of the account receivable by the company. Question Four As of December 31, 2009, the following balance sheet elements need adjustments; Prepaid expenses- The prepaid expenses needs some adjustments as at December 31 2009 since most of them are not related to the date and time which are recorded against them. Non current assets- The depreciation of non current assets are not shown in the balance sheet indicating that they are recorded at the historical value hence does not reflect the current cost of the fixed assets therefore, there is need for adjustments as of December 31 2009. Taxes accrued and withheld, since the company has been making losses but due to overstatement of the company revenues, it has been recording profits which does not exist in the real sense and as a result, the company has been overstating taxes due. Therefore, there is need to properly adjust the company profit accounts so that actual taxes may be accounted for in the income statement and in the balance sheet. Retained earnings needs to be adjusted since the company has been reporting losses for several years but still recording retained earnings. The company retained earning recording in the balance sheet has been overstated hence it needs adjustments. Accrued expenses should be higher since the company has not been paying its employees due to hard financial times but this has not been reflected in the balance sheet. As at 31 December 2010, prepaid expenses- The prepaid expenses needs some adjustments as at since most of them are not related to the date and time which are recorded against them. Taxes accrued and withheld as at31 December 2010, since the company has been making losses but due to overstatement of the company revenues, it has been recording profits which does not exist in the real sense and as a result, the company has been overstating taxes due. Therefore, there is need to properly adjust the company profit accounts so that actual taxes may be accounted for in the income statement and in the balance sheet Question five After the management had realized that the company is struggling financially, the management decided to overstates their account receivable and they did this one since 2009 two years down the line. Since Jacobs and Roberts were the top managers of the company and they were chief accounting officer of the company, they had a prior knowledge of the financial status of the company and went a head to sign a misleading collateral financial report hence they are part and parcel of the fraud. They assisted in fraud since the fraud started by recognizing revenue earlier before they could materialize and decided not to follow the GAAP principle and still go a head to sign the collateral report stating clearly that the report gives true and fair view of financial performance of the business. The top management consisting with Jacobs and Roberts were very keen in providing wrong information mainly to address the concerns of the banks. The banks requested that the company accounts should be audited and Robert personally made that commitment of ensuring that accounts are audited so in case of any misleading information, he is a ware of it and must be held personally responsible. The loan terms required the officers of the company to furnish them with collateral reports consisting of aged listing of accounts receivable within 20 days after close of each month. The reports were to be accompanied with by certification from an officer of VSI that the reports were complete and accurate. Jacobs and Robert signed the certification and went further to state that the accounts are prepared according to GAAP and meets the above criterion. Therefore we can conclude that the management knew what was going on in the company and should be held responsible for their omission and negligence. Question Six After Mr. Gray had decided to contact the customers of VSI Company over the substantial money they owe to the company, Robert decided to open up and admitted that the accounts receivable report is wrong and misleading. Jacob decided to admit and started clearly that whatever they did as the management of the company was only to save the job of the company employees and with time, they hoped to revive themselves out of financial difficulties they were facing as the company. From the statement of Mr. Robert, it is clear that they were working at the best interest of their employees but not the bank, the company management had prior knowledge of what was going on concerning the financial inflow and outflow but failed to inform the banks hence they should be held personally responsible for the loss the banks experienced. Question seven According to Standard Auditing and Practices (SAP), it is the responsibility of the auditor to detect fraud and an error in the financial statement of the company. SAP (4) gives rules and principles which an auditor should use before he can declare an error or fraud in the financial statement of a company and to prevent error or fraud, the responsibility lies with both the management of the company and the auditor (AAS Pg. 16). Misstatements in the financial statements might come as a result of an error or fraud (AAS Pg. 17). The term or word “error” in auditing terms can be defined as an unintentional misstatement in the financial statements. They include the omission of an amount or a disclosure such as; i. An error or mistake from gathering information from source document or original documents one uses in preparing final statements ii. A mistake which arises from incorrect accounting estimate which arises from an oversight or what is called misinterpretation of financial facts iii. Incorrect application of a given accounting principles which relates to measurements, classification, disclosure, presentation and recognition Fraud on the other hand can be defined as intentional act by one or more individuals either within the management or those who are charged with the company management, employees or parties within an organization (AAS Pg. 18). Fraud involves deception to get or obtain illegal advantage over someone or something. Fraud is a wider concept when it comes to criminal law, in Auditing according to SAP 4, fraud involve intentional material misstatement in the financial statements, though, it is not the work of an auditor to make legal determinations of whether fraud has actually occurred (AAS Pg. 22). There are two types of intentional misstatements an auditor can consider as a fraud. First, misstatement which arises from fraudulent financial reporting and secondly, misstatement resulting from misappropriation of assets. In financial reporting fraud, it involve intentionally omitting information or misstatements amounts or giving disclosures in financial statements in order to deceive the financial statement users. This may involve; i. Manipulation, falsification or alteration of accounting records to deceive final financial users ii. Misrepresentation in the financial statement and omitting significant information which might make the financial users to make otherwise decision iii. Intentional misapplication of accounting principles which relates to recognition, presentation, disclosure or recognition According to AAS 2, the sole objective of auditing is to ensure that financial statements are prepared according to accounting policies and principles which are relevant to the statutory requirements (AAS Pg. 16). Therefore it is the responsibility of an auditor to express their opinion on such financial statements. The auditor has the responsibility of ensuing and expressing that such financial statements are free from any kind of misstatement which is either caused by fraud or an error. Auditing activities should act as a deterrent to fraudulent activities or error but auditor can not be held responsible for the prevention of such activities (AAS Pg. 23). Question Eight One of the red flags in the case is the measure which the management had taken to restore their declining revenue of the company. First when marketing and sales cost are reduced, it is obvious that the company will not be making enough sales and with reduction in sales profit margin will be low yet the company was still posting high profits after that measurement hence this is a red flag. Reduction of salary only indicates reduction of one variable cost what about other variable cost, it means other variables cost remains the same and this might be insignificant step. Another red flag is the speed at which the company recovers from its financial melt down, it took less than four months fro the company to start posting profit yet how the sales have increased in not clearly explained. Deteriorating aging account also another red flags which the auditors ought to have seen, since there is no way you can continue offering services to clients who do not pay passed debtors period date. The rate at which the company had been taking overdraft is another red flag as company which is active and making profits should not take overdraft continuously yet they have signed for expansion loan. This was a red flag which would have alerted the company. Low cash both in hand at bank, low value of inventories yet high number of account receivable. The amount of account receivable is higher than the amount of account payable which is contrary to credit policies of any company, this was enough warning of a problem which they could have acted upon. Question nine From the auditing point of view, there is scanty report which could have made them realized that fraudulent activities were taking place. From the account receivable trial balance, there was earlier recognition of revenue for most of the debtors. This is a clear indication of misstatement and fraud according to auditing principles. According to SAP 4, fraud involve intentional material misstatement in the financial statements, though, it is not the work of an auditor to make legal determinations of whether fraud has actually occurred but his duty to detect. Since the company intentionally applied wrong accounting principles which relates to recognition of revenue, presentation, disclosure, auditors ought to have used this to help them detect fraudulent activities. In the original books and trial balance, there various instances of overstatements of account receivable which the auditors would have used to detect fraud in the company. Question Ten Loan before deteriorating profit started = $ 1,000,000 At this point account receivable was totaling to = $ 818,513 Cash at hand was = $6,455 If all the assets value is at zero Loan Interest 10% pa Interest accrued = 10% X 1,000,000 = $100,000 Total outstanding debt = $1,100,000 Against the security = $ 824968 Loss = ($ 824968-$ 1,100,000) December 2008 = ($ 275,032) Loan before deteriorating profit started = $ 1,000,000 At this point account receivable was totaling to = $ 1,023,623 Cash at hand was = $ $1,898 If all the assets value is at zero Loan Interest 10% pa Interest accrued = 2X10% X 1,000,000 = $200,000 Total outstanding debt = $1,200,000 Against the security = $ 1025521 Loss = ($ 1025521 - $1,200,000) December 2009 = ($174,479) Loan before deteriorating profit started = $ 1,000,000 At this point account receivable was totaling to = $ 1,744,807 Cash at hand was = $$1,700 If all the assets value is at zero Loan Interest 10% pa Interest accrued = 3X10% X 1,000,000 = $300,000 Total outstanding debt = $1, 300,000 Against the security = $ 1,746,507 Loss = ($1, 300,000 - $ 1,746,507) December 2010 = ($446,507) Conclusion The management was entirely to be blamed for the fraudulent activities which had taken place within the company and the company custodians should be individually held responsible for committing fraud by misstating the actual financial position of the company leading to misstatement of information and as a result the Bank management made wrong decision of advancing more credit and by the end the bank made loses. Reference AAS (2010), Paragraph 15 of AAS 28, "The Auditor's Report on Financial Statements" describes auditing standards generally accepted in U.S.A Pg. 14-22 GAAP (2009) Generally Accepted Accounting Principles Pg 12-56 Read More