Management can perpetuate financial reporting frauds by overriding established control procedures and recording unauthorized or inappropriate journal entries or other closing adjustments. Grantees will find this information useful in preventing similar occurrences from happening within their organizations. Show
The following is an excerpt from Fraud Detection in a GAAS Audit. Examining Journal Entries and Other AdjustmentsManagement can perpetrate financial reporting frauds by overriding established control procedures and recording unauthorized or inappropriate journal entries or other post closing adjustments (for example, consolidating adjustments or reclassifications). For example, SEC Accounting and Auditing Enforcement Release No. 1287 (Guilford Mills, Inc.) describes a situation in which the controller entered false journal entries debiting accounts payable and crediting purchases (cost of sales). The effect was to understate payables and significantly increase earnings. To address situations such as these, SAS No. 99 requires you to test the appropriateness of journal entries recorded in the general ledger and other adjustments. Understanding the financial reporting process. To effectively implement this required procedure, you will need to obtain a good understanding of the entity's financial reporting process. This understanding is important because it allows you to know what should happen in a "normal" situation so you can then identify anomalies. The following table describes example inquiries you may consider making of entity personnel. Adjacent to each inquiry is a description of how the information learned from the answer can help you identify and select journal entries and other adjustments for testing.
Your understanding of the financial reporting process also should include knowledge of how journal entries are initiated, recorded, and processed (for example, directly online or in batch mode from physical documents), the design of any controls over journal entries and other adjustments, and whether those controls have been placed in operation. This information will help you design suitable tests. BrainstormingAs part of your brainstorming session, you should consider discussing how journal entries may be used to perpetrate or conceal a fraud. For example, you might discuss:
InquiriesAs part of your inquiries of management and others about fraud-related matters, you should consider asking accounting, data entry, and IT personnel about whether they have observed any unusual accounting entries during the audit period. Identifying journal entries and other adjustments for testing. Your assessment of the risk of material misstatement due to fraud, together with your assessment of the effectiveness of controls, will determine the extent of your tests. SAS No. 99 requires that you inspect the general ledger to identify journal entries to be tested and examine the support for those items. This procedure is required even if you determine that controls over journal entries and other adjustments are operating effectively. When testing journal entries and other adjustments, it is vital that you identify and consider the entire population of journal entries and other adjustments. Be aware that some entries and adjustments may be made outside of the general ledger. For that reason, you will need to obtain a complete understanding of how the various general ledgers are combined and the accounts are grouped to create the financial statements. SAS No. 99 (AU sec. 316.61) provides the following guidance on what to consider when selecting items for testing. Characteristics of Fraudulent Entries or Adjustments
The Nature and Complexity of the Accounts
In addition to these items, you should consider journal entries and other adjustments that are processed outside the normal course of business ("nonstandard" entries and adjustments). Considering CAATsComputer assisted audit techniques may be required to identify entries that only exist electronically. CAATs may be necessary to identify the complete population of journal entries and other adjustments to be tested. In addition, CAATs may be used to detect:
Testing Journal Entries and Other AdjustmentsOnce you identify journal entries and other adjustments for testing, you should examine documentary evidence indicating that they were properly supported and approved by management. Because fraudulent journal entries often are made at the end of a reporting period, your testing ordinarily should focus on the journal entries made at that time. However, you should not completely ignore journal entries made throughout the period. PITF Practice Alert No. 03-2, Journal Entries and Other Adjustments, provides additional guidance on the procedures you should consider to review journal entries and other adjustments for signs of management override of internal control. That Practice Alert is included as Appendix C to this book. Retrospective Review of Accounting EstimatesAccounting estimates are particularly vulnerable to manipulation because they depend so heavily on judgment and the quality of the underlying assumptions. For that reason, SAS No. 99 requires you to perform a retrospective review of prior-year accounting estimates for the purpose of identifying bias in management's assumptions underlying the estimates. This review is not intended to call into question your professional judgments made in prior years that were based on information available at the time. Rather, this retrospective review should be considered within the context of its implications for the current year audit, and the facts and circumstances that currently exist. Although this procedure is included in that section of the standard used to describe responses to management override, it might also have been included as part of the information-gathering phase of the engagement. That is, the information you gain from a retrospective review of management's assumptions underlying key estimates may be used to identify risks of material misstatement due to fraud. Business Rationale for Significant Unusual TransactionsMany financial reporting frauds have been perpetrated or concealed by using unusual transactions that are outside the normal course of business. For that reason, SAS No. 99 requires auditors to understand the business rationale for these types of transactions. SAS No. 99 (AU sec. 316.67) provides an excellent list of items you should consider when understanding the business rationale for unusual transactions. As indicated in SAS No. 99, entities intent on fraudulently reporting financial results may use related party transactions to perpetrate or conceal the fraud. The most common related party transactions used for these purposes include the following.
As indicated in SAS No. 99, these types of related party transactions, per se, do not constitute fraudulent financial reporting. However, if these transactions were entered into without proper approval, or if entity management did not identify these transactions for you, there may be indications that fraudulent financial reporting is being concealed. Last Updated: September 12, 2021 What control procedures should be used to reduce the risk of unauthorized disclosure?What control procedure(s) should be used to reduce the risk of unauthorized disclosure of the financial statements? create a standard adjusting journal entry file. Identify the year the SEC will require American companies to switch from U.S.-based GAAP to IFRS as the basis for preparing financial statements.
What control procedure should be used to reduce the risk of the destruction of financial statement master data?What control procedure(s) should be used to reduce the risk of the destruction of financial statement master data? Backup and disaster recovery.
Which of the following are used to document entries made to update the general ledger a general journal B subsidiary journal C subsidiary ledgers D journal vouchers?Answer: A journal voucher is a form on which journal entries to update the general ledger are documented. The individual entries are stored in the journal voucher file.
What are the advantages of using XBRL?XBRL offers major benefits at all stages of business reporting and analysis. The benefits are seen in automation, cost saving, faster, more reliable and more accurate handling of data, improved analysis and in better quality of information and decision-making.
|