Fraud Risk Mitigation Strategies

This assignment examines the potential for fraud within companies, highlighting two specific areas of concern: a lack of clear authority structures that can lead to fraudulent activities by employees, and the management's hasty installation of a new IT system without proper research or due diligence. The document emphasizes the importance of auditors in mitigating these risks through strategies like surprise checks, expert opinions, cost-benefit analysis of new systems, and reconciliation of financial records. It also discusses the auditor's role in modifying audit reports to reflect discrepancies and potential material misstatements.

By student name
Professor
University
Date: 25 August 2017.

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Contents
Question no 1…………………………………………………………………...2
Question no 2…………………………………………………………………...6
Question no 3…………………………………………………………….....….8
Refrences.....……………………………………………………………….......10
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Question no one
With the release and introduction of International Financial Accounting Standards and other
regulations of Accounting Standard Board, Audit has taken special significance and holds utmost
importance. It gives the reasonable assurance to the users of the financial statements, both internal and
external, which includes customers, shareholders, creditors, debtors, banks, financial institutions, etc.
Audit is an independent check of the financials prepared and reported by the entity, whether
government or private, small or large, with a view to express and opinion whether the same has been
prepared on an unbiased basis. Management also makes use of the estimates, assumptions and
judgements in several areas, which cannot be clearly defined, for all such areas; auditor needs to verify
whether the appropriate assumptions have been taken (Knechel & Salterio 2016). There are various
methods through which the auditor carries out his checking. This includes inspection of the critical and
important general ledgers, observation of the activities happening within the premises of the client like
physical verification of the stock, taking external confirmation from the banks and financial institutions
and creditors. Along with that inquiring from the external parties and customer about the client business
and it environment, performance of the significant activities and calculations like tax, which may have a
huge bearing on the cash flow and applying further analytical procedures. Auditors generally apply
substantive procedures to see the viability and the existence of the numbers recorded to evidentiate
substance over form. They want to check the completeness of the transaction along with the supporting
and relevant evidences, disclosures which have been given in the financials and whether the valuation
has been correctly and reliably done or not for the cases where it requires so. Substantive audit
procedures included vouching of the expenses and incomes recorded in the books and verification of
the liabilities and the assets, which are appearing in the statement of affairs as on the reporting date.
The sales are checked with the invoice and bills, the costs and expenses incurred are reconciled with the
purchase orders raised and vouchers, etc. The assets are checked from the agreement or lease deed,
etc., and for the liabilities, their existence is determined by external confirmation (Jones 2017).
Besides all the above procedures, analytical procedures holds a special significance as to
determine the nature of checking, timing to be assigned and the extent to which the sample verification
is to be done. All this determines the final qualification of the audit report and it is all dependent largely
on the internal control procedures being followed within the company. More effective the test of
control and test of design within the organisation, lesser the risk and lesser is the application of audit
procedures to be applied. On the other hand, the more ineffective the control within the organization,
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the more are the chances of the risks and more would be the extent of the checking required. Analytical
procedures, hence, are applied on both the financial and non-financial data (Raiborn, Butler & Martin
2016). Examples of some of the procedures include ratio analysis over a period of time, trend analysis
based on the industry figures, variance analysis, reasonableness testing and analysis of the actual data at
the end of the period with the expected and budgeted figures. All this procedures depend directly on
the understanding of the auditors of the business environment and its businesses. All the testing and
verification done should be adequately documented in order to draw the conclusions at the end
(Grenier 2017).
In the given case, Stewart and Kathy are taking over as the auditors of DIPL from the old
auditors Jay and Associates. Therefore not only substantive and analytical procedures, but the checking
of the opening balances is also required to ensure that there is no material misstatement and it poses no
risk to the financials. Here the analysis has been done using the limited data given which helps in
establishing the trend of the profitability, debt management and liquidity ratios over a period of last 3
years. Besides this, auditor also needs to validate the procedure of payment to vendors in foreign
currency that whether the exchange rate fluctuations is properly accounted for, whether the inventory
is correctly valued as per the accounting standards at the end of the period. It is important to see
whether the revenue is being recognised using the correct ways using IFRS 115 or simply the dispatch or
movement of goods out of factory determines the revenue recognition. All this is important to check the
validity of the financials of the company and judge its overall liquidity (Fay & Negangard 2017).
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
Results: Here the current ratio as well as the liquid ratio has just about reached near the industry standard of 2 & 1
respectively. However, it is still to cheive in the future. In addition, since as per the loan agreement with BDO Finance Ltd.,
current ratio was to be atleast 1.5, which the company was just about reached in 2015.
1. Short term solvency or liquidity Ratios
Current Ratio = Total current assets/ Total current liabilities
Liquid ratio /Quick Ratio = (Total current assets - Inventory - Prepaid
expenses)/ Total current liabilities
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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%
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
2. Debt Management Ratios
3. Asset management Ratios
Results: The Debt equity ratio here has increased from 0.4:1 to 1.13:1 over the period of 3 years which is still below the
industry standards of 2:1 but as per the loan agreement, the ratio was required to be within 1, which has been crossed in
2015 financial year.
Results: Asset management ratios show a drastic fall in both the receivables cycle and the inventory turnover cycle as both
of them increased by around 50% which shows that the company hasn't been able to maintain effctivity over the business
cycle and the control procedures haven't been as was required.
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)
Inventory Turnover = COGS/Inventory
Days' Inventory = 365/Inventory Turnover
Fixed Assets Turnover = Sales/net Fixed Assets
Total Assets Turnover = Sales/Total Assets
Receivables Turnover Ratio = Sales/Accounts Receivable
Days Receivable = 365/Receivable turnover
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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%
4. Profitability ratios
Results: All the 3 ratios calculated here are evident of the fact that the ratios have been stagnant in the last 3 years near to
6% and has neither increased or decreased even after taking benefit of increased loan in the capital structure.
Profit Margin / Net Profit ratio = Net income / Sales
Operating Margin ratio = Operating Profit/Sales
Return on Equity = Net income/total owners' equity
From the above ratio analysis, it can be inferred that the both the liquidity ratios namely current and
liquid ratio are below industry standards of two & one respectively. In addition, the debt equity ratio is
below the standard of 2:1 therefore, it is having the cushion of trading on equity in the future and
incurring low interest costs. As per the results, it does not suffice the bank loan terms of current ratio of
at least 1.5 and debt equity ratio of 1:1; hence, it may be that the loan may be revoked if the company is
not able to meet the given standards. In addition to this, the asset management ratio show that the
receivables ageing as well as the inventory liquidation ageing has increased by around 50% which means
the cash collection and the inventory cycle has increased in terms of days, this will badly impact the
DSO. In addition, the asset turnover ratio has decreased drastically over the period of last 3 years
implying that the assets are having wear and tear and it is not generating the amount of sales as it was
doing in the initial years. The last but not the least, profitability ratios imply that it has remained
constant over the last 3 years at around 6%. Even the return on equity has remained the same at 24%,
which implies that the company has not been able to meet the increased demand of the shareholders
even after increasing the amount of debt in the capital structure. Overall, the financial position of DIPL is
constant and is below average.
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Question 2
There are different types of risk that are associated with auditing. The three major type of risk
are inherent risk, control risk and detection risk. Inherent risks occurs when things are not in the hands
of the management even after applying proper internal control methods, the control risk occur when
there is lack in internal control by the management, and detection risk occurs when the auditor fails to
detect major errors in the books of the company. In case of DIPL, also, the company faces few inherent
risks in the audit process and the same is given below.
s.no Issue Involved Type of risk Reason of risk Mitigation of risk
1 The main issue is that
there is a change in the
non-routine methods of
the company.
It is type of inherent
risk that is associated
with changes in the
overall procedures of
an organisation.
The main reason of risk
is that in cases where
the company is trying to
adopt new methods and
procedures, the auditor
will find it difficult to
quantify the changes
materially. Like in case
of DIPL, the coo is
considering changing the
method of calculation of
depreciation, adopting
new methods and
making changes. These
changes are based on
the knowledge of the
CEO and tree has been
no proper research in
that regard. Also the
company wants to
change the method of
valuation of inventory.
We see that with all
The auditor can
mitigate the risk,
by asking the
management to
undertake proper
research before
making such
changes. It is
important proper
disclosures
regarding all the
major changes are
properly given by
the auditor so that
the financial
statements show
the true state pouf
affairs of the
company.
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these changes the
overall functionality of
the organisation get
changes. There are few
assumptions that the
company is making, it
may be possible that it is
not financially viable
(Sonu, Ahn & Choi 2017).
2 The second issue is
associated with the
launching of the new IT
system.
It is type of risk that
is associated with
change in the
current procedures
without undertaking
proper research.
The main risk is
associated with the
launching of the new IT
system without proper
research. It may be
possible that there is
undervaluation or
overvaluation of the
system that might affect
the overall profitability
of the company. It is
thus important that
before taking such steps
the management does
not haste and undertake
expert opinion (DeZoort
& Harrison 2016).
The auditor can
mitigate the risk
by asking the man
agent to provide
with all the valid
details regarding
the new system
and also thy must
undertake proper
research before
undertaking so.
Solution 3
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Fraud occurs when the management or employees of the company indulges in certain activity that
might affect the financial viability of the company for their own personal motives and gain. It is
important for the auditor to apply all kind of substantive and analytical methods to make sure that the
books of the company are able to portray the true state of affairs and there are no errors or fraud. In
case of DIPL, there are few potential fraud risk factors, the same has been explained here under-
s.no Issue Reasons of fraud risk Mitigation of fraud
1 The major fraud
risk is associated
with no
segregation of
duties between
the employees in
case of important
work department
The main reason of risk is that in case of DIPL,
there is no proper segregation of work. The
account receivable department is handled by a
single clerk, who does all the work of making
the invoices, deciding the pricing, verifying the
transaction and making the payment. The cash
collection is also handled by a single clerk who
downloads the e receipts, verifies the accounts,
updates the books and reconciles them. Thus
there is an issue of no segregation of important
work between the employees and hence it
would be very difficult for the management to
ascertain proper authority in case there is
failure on part of the employees (Bae 2017).
The management can
mitigate the fraud by
taking important steps
of segregation of work,
and asserting that
proper controls are
there. The auditor can
ask the management to
do surprise checks and
verify the accounts
regularly so that the
employees cannot
indulge in any kind of
fraud. This is very
important that proper
authority is established
by the management so
that work is properly
dividend and check
points must be there to
ascertain their overall
validity.
2 The second type
of issue is in the
installation of the
The main reason is that there are high chances
that the management has installed the new
system in so much haste because there was
It is important that the
auditor takes important
steps to mitigate the
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major IT system
by the
management
without any
proper research.
some personal motive involved of the
management. The new system was installed
without any reconciliation, any research, it
might affect the overall profitability of the
company hampering its growth and
development. There might be undervaluation
or overvaluation of the new system which
might have risk of material misstatement on the
books of the company (Jones 2017).
overall risk of the
company. The auditor
should ask the
management to present
them with important
documents regarding
the company, to make
take expert opinion
before installing the
new system. It should
also reconcile the
overall cost and profit
to see the profitability
of the system and
should also check its
effect on the financials
of the company. The
management should
provide the auditor
with all the support and
documents. In case the
auditor finds any
discrepancies, he can
modify the audit report
and give a disclaimer
opinion. These are the
few ways in which the
auditor can mitigate the
overall risk of fraud that
is associated with the
company.
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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.
Jones, P 2017, Statistical Sampling and Risk Analysis in Auditing, Routledge, NY.
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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