Considering Fraud in a Financial Statement Audit:



Considering Fraud in a Financial Statement Audit:

Practical Guidance for Applying SAS No. 82

Excerpt from Part Three of the AICPA’s new publication:

Purchasing and Payroll is just one of several components covered in this section. . .

PURCHASING AND PAYROLL

Misappropriation of Assets

Typical Frauds

The purchasing function is particularly vulnerable to fraud. For many small businesses it represents the largest area of the risk of embezzlement.

The most common fraud scheme is the payment of invoices to a fictitious company. To perpetrate this scheme, the embezzler establishes a fake entity (often with

a P.O. Box for an address, and a name similar to that of a legitimate company) and gets the fake entity entered in to company records as a legitimate vendor. The

embezzler then produces invoices for the fake vendor, which are processed by the accounts payable system. Sometimes the embezzler is responsible for authorizing

payment but other times not. The scheme may also require collusion between various employees, such as receiving (doctoring a receiving report to indicate

something was received) and accounts payable (approving the invoice for payment).

Another common fraud is a kickback paid by vendors to the company=s purchasing agent. In collusion with suppliers, a purchasing agent may get paid a kickback

for any number of activities including:

Allowing the vendor to submit fraudulent billing and approving the payment. Examples of fraudulent billing practices include: billing for goods or services never

performed or received, billing more than once for the same item, substituting lower quality items than the ones billed, or over billing for the items delivered.

Excess purchasing of property or services

Bid rigging

Kickbacks are "off-the-book" frauds, that is, their concealment is not recorded on the books of the company. For that reason, it is often difficult for auditors to

detect the presence of kickbacks.

The most common payroll fraud is the use of ghost employees, where the embezzler enters fictitious employees into the payroll system and receives the resulting

payroll checks. A variation on this scheme is to keep terminated employees on the payroll several pay periods after they leave their job. The embezzler then receives

the paycheck for the terminated employee.

Another payroll fraud is an overpayment scheme. These schemes involve higher pay rates, inflated hours or days, or unauthorized bonus pay. Duplicate payroll

checks for the exact amount of the legitimate check are also common.

What to Look For

In addition to the items listed in paragraphs 19, 20, and 25 of SAS No. 82, be alert for the following, which may be present when the frauds described above are

occurring or have occurred:

Fictitious vendors

Photocopied invoices or invoices that have been tampered (for example, sections have been "whited out" and typed over)

Invoice numbers from the same vendor that occur in an unbroken consecutive sequence

Invoices from companies with a P.O. Box address and/or no phone number

Invoices from companies with the same address or phone number as an employee

The amount of each invoice from a particular vendor falls just below a threshold for review

Multiple companies that have the same address and phone number

Vendor names that appear to be a "knock-off" of well-established businesses (i.e., names spelled very similarly to well-established businesses)

Kickbacks

Purchasing agent handles all matters related to a vendor even though it might be outside or below his or her normal duties

Vendors who receive an inordinate amount of business from the company for no apparent business reason

Vendor salesmen make frequent, unexplained visits to purchasing personnel

Prices from a particular vendor are unreasonably high when compared to others

Quality of goods or services received from a vendor is low

Tips or complaints from other employees or honest vendors

Key contracts awarded with no formal bid process

Purchase of excess goods

Ghost Employees

Employees with duplicate addresses, checking accounts, or Social Security numbers

Employees with no withholding taxes, insurance, or other normal deductions

Example Audit Procedures

The following audit procedures should help detect the frauds described above. Depending on your assessment of the risk of material misstatement due to fraud, these

procedures may be performed as part of an audit conducted in accordance with GAAS. Alternatively, they may be performed outside the scope of a GAAS audit. If

your assessment of risk of material misstatement due to fraud requires you to respond and an example procedure is already part of your planned approach, consider

expanding the extent of testing, perhaps by selecting more items.

Review selected invoices and look for evidence that the invoice has been doctored.

Perform a computerized search of the vendor list and look for: P.O. Box addresses, duplicate addresses, and vendors with no phone number.

Determine if vendors are listed in yellow pages of phone book. Call vendors if considered necessary.

Perform a computerized match of the vendor list with a list of employees and look for matches of addresses or phone numbers.

Perform a computerized sort of invoices by vendor and look for unusual sequencing or amount (indication of possible fictitious company). Look for unusual pricing and volume trends (indication of possible kickback).

Review selected invoices and examine supporting documentation indicating goods or services were received.

Perform a computerized search of payroll records to identify duplicate addresses, Social Security numbers, or bank accounts.

Verify Social Security numbers by calling the Social Security Administration.

Review personnel files and look for those that contain little or no evidence of activity (for example, a lack of performance evaluations, requests for changes to withholdings, or retirement plan options).

Observe a payroll check distribution. Determine why unclaimed checks were not claimed.

Because kickbacks are conducted off-the-books, they may be difficult to detect using traditional audit techniques. If your client has reason to believe a purchasing agent is accepting kickbacks, a fraud examination may be required.

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