Fraud Risk Assessment in DIPL

This assignment examines potential fraud risks within the context of DIPL, specifically addressing the challenges auditors face in identifying such risks. It delves into two key areas: inadequate segregation of duties that can facilitate fraudulent activities and the implementation of a new IT system without proper reconciliation, potentially driven by personal motives of directors. The assignment emphasizes the crucial role of auditors in mitigating these risks through measures like ensuring work segregation, conducting thorough reconciliations, and scrutinizing management justifications for haste.

By student name
Professor
University
Date: 16 August, 2017.

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Contents
Question no 1…………………………………………………………………...2
Question no 2…………………………………………………………………...5
Question no 3…………………………………………………………….....….7
Refrences.....………………………………………………………………....... 9
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Question no 1
Audit is an independent examination of the financial statements and books of accounts
prepared by the management by the auditors of the company to check whether the financials are
showing correct and unbiased view of the state of affairs and to express their opinion thereof. Audit is
generally conducted using the substantive and analytical procedures. Substantive audit procedures are
of great relevance in ascertaining whether all the audit procedures an d cares and check have been
applied consistently and thoroughly while preparing the books of accounts and preparation of financial
summary. It generally includes vouching of incomes and expenses and verification of assets and
liabilities. But when these 2 measures are not sufficient and does not gives the confidence on the
arithmetical accuracy of the books of accounts then the auditor has to switch to analytical procedures
which includes ratio analysis, trend analysis, variance analysis and a study of fluctuation in the numbers
based on the past financial statements. For this, generally the data points include the past years
financial data, the industry trend and average, the budgeted numbers and the forecasted numbers. IN
case of DIPL limited, the auditors have also changed as compared to the last year, so substantive
procedures would not be enough & the new auditors would have to resort to the analytical audit
procedures to gain the confidence on the transparency of the accounts prepared and the verification of
the opening balances of the client. If post all this comparison, we would come to know that still the
decision cannot be taken whether the books are to materially misstated, then the auditors would have
to increase their scope of check and would have to apply further analytical procedures keeping into
consideration the maintenance of the internal financial control in the company by the management. If
the internal financial controls are adequate, less is the amount of risk, less will be the deviation of the
actual from the standard and hence, less is the extent of checking reqd., however, in the other case,
weak the leave of internal control maintained by DIPL, the more is the level of analytical procedures to
be applied. Further, the management needs to answer all the queries raised b the new auditors in case
of any clarifications. There are various ways in which the auditor can use these analytical procedures for
ascertaining the credit viability of the company. The examination of the financial statements of previous
year can be done, by derivation important key financial ratios that help the auditor in forming an
opinion on the financial viability of the company. In addition, comparison with the set industry standards
can be done accordingly, by trend analysis and making forecasts and budgeting. If the auditor finds from
any deviation from the expected standards then he needs to find the reason of the same and approach
the management to comment on the same. These are few basic tools of analytical analysis, that can help
the auditor in making a statement (Bae 2017). In the given case study, financial information of past years
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from the books of account of the company is given. Data can be taken from the same to calculate
important ratios, industry data is not available so it will be difficult to comment on the standing of the
company, with respect to specific industry qualifications and provisions. The analytical procedures
applied here would be reflected by means of the below mentioned table. All the data has been collected
from the books of account of the company and an opinion on the same is given by making use of specific
tools, as depicted hereunder-
1. Short term solvency or liquidity Ratios
2013 2014 2015
Total current assets 5,385,938 7,509,150 9,600,929
Total current liabilities 3,780,000 5,120,250 6,397,500
Result 1.42 1.47 1.50
2013 2014 2015
Total current assets - Inventory - Prepaid expenses 3,129,750 4,837,788 5,420,429
Total current liabilities 3,780,000 5,120,250 6,397,500
Result 0.83 0.94 0.85
2. Debt Management Ratios
2013 2014 2015
Total Debts 3,780,000 5,120,250 13,897,500
Total Assets 5,120,250 15,903,900 26,147,991
Result 74% 32% 53%
2013 2014 2015
Total Debts 3,780,000 5,120,250 13,897,500
Total owners' equity 9,150,000 10,783,650 12,250,491
Result 41% 47% 113%
Current Ratio = Total current assets/ Total current liabilities
Liquid ratio /Quick Ratio = (Total current assets - Inventory - Prepaid
expenses)/ Total current liabilities
Debt ratio = (Total Debts / Total Assets) or ((Total assets- total owners'
equity)/total assets)
Debt to Equity Ratio = (Total Debt/Total owners' equity) or ((Total assets-
total owners' equity)/total owners' equity)
Ratio Analysis
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3. Asset management Ratios
2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Accounts Receivable 2,482,500 4,320,000 5,073,309
Result 13.78 8.73 8.57
2013 2014 2015
No. of days 365 365 365
Receivable turnover 13.78 8.73 8.57
Result 26.49 41.83 42.61
2013 2014 2015
COGS 28,207,500 31,620,000 36,855,000
Inventory 2,256,188 2,671,362 4,180,500
Result 12.50 11.84 8.82
2013 2014 2015
No. of days 365 365 365
Inventory turnover 12.50 11.84 8.82
Result 29.19 30.84 41.40
2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Net Fixed Assets 7,544,062 8,394,750 15,572,062
Result 4.53 4.49 2.79
2013 2014 2015
Sales 34,212,000 37,699,500 43,459,500
Total Assets 12,930,000 15,903,900 26,147,991
Results 2.65 2.37 1.66
4. Profitability ratios
2013 2014 2015
Net income 2,359,190 2,291,362 2,972,183
Sales 34,212,000 37,699,500 43,459,500
Result 6.90% 6.08% 6.84%
2013 2014 2015
Operating Profit 6,780,000 7,230,000 8,308,088
Sales 34,212,000 37,699,500 43,459,500
Result 19.82% 19.18% 19.12%
2013 2014 2015
Net income 2,359,190 2,291,362 2,972,183
Total owners' equity 9,150,000 10,783,650 12,250,491
Result 25.78% 21.25% 24.26%
Inventory Turnover = COGS/Inventory
Days' Inventory = 365/Inventory Turnover
Fixed Assets Turnover = Sales/net Fixed Assets
Total Assets Turnover = Sales/Total Assets
Profit Margin / Net Profit ratio = Net income / Sales
Operating Margin ratio = Operating Profit/Sales
Return on Equity = Net income/total owners' equity
Receivables Turnover Ratio = Sales/Accounts Receivable
Days Receivable = 365/Receivable turnover
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Question 2
There are various types of risks that are associated in audit of an organisation, that might affect
the standing of the auditor and prevent them from forming an opinion on the financial statements of
the company. The three types of risks are Inherent risk, control risks and ejection risks. Inherent risk is
the major type of risk that occurs in situations that are not in control of the management. Control risks
are the type of risk in which there is risk of lack of proper internal control o part of the management. In
addition, detection risks occur when the auditor fails to notice an error that can be easily identifiable. In
the given case of DIPL, there are certain inherent risks that are to be identified by the auditor. The
auditor must also take measures to ensure mitigation of the risks. (Raiborn, Butler & Martin 2016)
Inherent risk Reasons of inherent risk Risk of material misstatement
The company faces an inherent
risk of non routine transactions
and adopting new changes in
the statement.
The main reason that is a risk on
part of the auditor to comment
on the financial viability of the
company, because the IT system
which the company is installing
is entirely new. The IT system is
a deviation from routine
matters, there is no standard
basis with which the auditor can
compare its effectiveness. The
system is installed under acute
pressure from the management
without any reconciliation
between the pre operating
activities and the results there
of. These factors behind the
installation of the new IT
system, makes it probable to
consist of certain risk that is not
in the hands of the
management and the auditor.
The risk of material
misstatement encompasses the
fact that it is possible that the
management might have failed
to include all material facts in
the financial statements
accurately. The main reason
behind the same might be the
presence of inherent risks and
control risks in the operations
that have prevented the auditor
from forming a correct opinion
on the financial statements. In
the given case, if the company
fails to properly reconcile all the
operations with respect to the
new IT system there is high
chances that there might be
misstatement in the financial
statements of the company.
This may be reflected in the
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Also the management has failed
to ascertain effective control in
maintenance of the same, thus
the risk chances increases
because of lack of proper
internal control facilities (Sonu,
Ahn & Choi 2017).
overvaluation or the
undervaluation of the system.
There may be chances of
default in the revenue system
also because of the same.
2) The second type of inherent
risk may be associated with the
changes in the accounting
policies and assumptions of the
company by the board of
directors.
The main reason behind the
same is that it is stated in the
reports of the management that
the management is considering
change in the accounting
policies and estimates.
Proposals have been given on
not using the average cost for
the valuation of the inventory
and new cost methods should
be implied. Also the
management is considering
changes in the method of
calculation of depreciation and
reporting on the same. Only
based on the experience of the
board members the company is
considering changing the
method of depreciation and
assuming the life of the asset to
be 30 years, even though as per
the industry specifications the
life must be 20 years (DeZoort &
Harrison 2016).
This will be lead to material
misstatement because the
management is changing the
policies and maki9ng
assumptions without any
proper research and
consideration and that may
affect the financial position of
the company. The auditor will
have problem in ascertaining
the viability of the books of
account in chances of change of
accounting policies and
estimates. Proper disclosure is
to be given by the management
to make sure all the changes are
properly recorded and stated.
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Question no 3
Fraud can occur in the preparation of the financial statements and the main work of the auditor
is to identify such fraud risk factors and to eliminate the same. In the books of account of DIPL and the
statement presented by the company, many lead two fraud risk factors to falsification of the books of
account.
Fraud Risk Risk Factor Identified Approach of the auditor
1) The major fraud risk factor is
that there is no proper
segregation of duties in major
areas and one person is given all
the responsibility.
It is one of the major reasons
that may lead to fraud because
one person has got access to all
the important areas. In case of
DIPL, the clerk is given
important work related to
invoice preparation and its
presentation and also
authorises the same for
payment. There is only level of
check there in the form of the
accounts receivable clerk who
checks the mathematical
accuracy of the invoices and
makes the payment. In case of
cash related activities, the e
receipts are downloaded,
verified and authorised by a
single person, and then
reconciliation of the statements
is also done by the same
person. Thus we see that there
is little or no control, because
even if the person does any
fraud in the account, it will be
To prevent such fraud risk
factors, the auditor must ask
the management to ensure
proper segregation of work.
There must be clear check
points, so that any entry, any
amount passes through at least
two check points, before being
finalised. The auditor in case he
ascertains that any fraud has
occur can bring up the matter
directly to the management and
can ask the management to
change the present position of
the person at fault, so that
proper observations may be
drawn in lack of any
manipulation from the
defaulted party (Knechel &
Salterio 2016).
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hard for the auditor and the
management to identify the
same.
2) The second area of fraud in
case of DIPL, can be the
implementation of the new It
system without any proper
reconciliation. It is possible that
personal motives of the
directors may be involved in the
same.
There are chances of fraud
because the system was
installed without proper
reconciliation and checking, and
also there are no proper
parameters in which the auditor
can compare its efficiency and
verification. It may be possible
that the management had
certain personal gains involved
in the same, and the
management wanted to do it in
haste so that they can avoid any
discrepancies that may arise if
proper reconciliation is done.
(Fay & Negangard 2017)
The auditor should make sure
that all the details regarding the
new system are derived from
the management. Proper
scrutiny of the books of
accounts and third party check
must be done, to ensure its
effectiveness and verify its
credibility. The reasons of haste
must be justified and the
auditor must ask the
management to conduct
important reconciliation and
provide the report as soon a
possible. These are the few
ways in which the auditor can
mitigate the fraud factor form
the books of accounts of the
company. (Grenier 2017)
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References
Bae, SH 2017, 'The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From
Korea', Journal of Applied Business Research, vol 33, no. 1, pp. 153-172.
DeZoort, FT & Harrison, PD 2016, 'Understanding Auditors sense of Responsibility for detecting fraud
within organization', Journal of Business Ethics, pp. 1-18.
Fay, R & Negangard, EM 2017, 'Manual journal entry testing : Data analytics and the risk of fraud',
Journal of Accounting Education, vol 38, pp. 37-49.
Grenier, J 2017, 'Encouraging Professional Skepticism in the Industry Specialization Era', Journal of
Business Ethics, vol 142, no. 2, pp. 241-256.
Knechel, WB & Salterio, SE 2016, Auditing:Assurance and Risk, 4th edn, Routledge, New York.
Raiborn, C, Butler, JB & Martin, K 2016, 'The internal audit function: A prerequisite for Good
Governance', Journal of Corporate Accounting and Finance, vol 28, no. 2, pp. 10-21.
Sonu, CH, Ahn, H & Choi, A 2017, 'Audit fee pressure and audit risk: evidence from the financial crisis of
2008', Asia-Pacific Journal of Accounting & Economics , vol 24, no. 1-2, pp. 127-144.
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