Govbusman Module 9 (12) - Chapter 15 PDF

Preview

Summary

Chapter 15: ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITYExpected Learning OutcomesAfter studying the chapter, you should be able to ...Understand errors and frauds that may be committed in the business processes, namely: a. Sales and Collection Cycle b. Acquisition and ...

Description

Chapter 15: ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY Expected Learning Outcomes After studying the chapter, you should be able to … Understand errors and frauds that may be committed in the business processes, namely: a. Sales and Collection Cycle b. Acquisition and Payment Cycle c. Payroll and Personal Cycle

While business is different individuals can have striking different characteristics, most of them have some fundamental conceptual characteristics and practices in common. The three basic business transaction cycles include: 1. Sales and Collection Cycle 2. Acquisitions and Payment Cycle 3. Payroll and Personnel Cycle Management should establish controls to ensure that these transactions are appropriately handled and recorded. However, if internal controls are not properly implemented, or are overridden, fraud and errors may occur. This chapter presents errors and fraudulent activities that could result if there is poor internal control. I.

Sales and Collection Cycle 1. Errors in Recording Sales and Collections Transactions Errors in recording sales include mechanical errors, such as using a wrong piece or wrong quantity, recording sales in the wrong period (cutoff errors), a bookkeeper’s failure to understand proper accounting for a transaction, and so on. Internal controls are designed to prevent or detect many of these kinds of errors. 2. Frauds in Sales and Collections Frauds in sales generally relate to fraudulent financial reporting. In contrast, frauds in cash collections relate to misappropriation of assets, typically accomplished by clerks or management-level employees. a. Fraudulent financial reporting involving sales typically results in overstated sales or understated sales returns and allowances. Managers under pressure to achieve high profits may inflate sales to meet target profits established by senior managers, to obtain bonuses, to retain the respect of senior managers, or even to keep their jobs. The following methods can be used to increase sales fraudulently:

         b.

II.

Recording fictitious sales (creating fictitious shipping documents, sales invoices, and so on) Recording valid transactions twice Recording in the current period sales that occurred in the succeeding period (improper cutoff) Recording operating leases as sales Recording deposits as sales Recording consignments as sales Recording sales when the chance of a return is likely Following revenue recognition practices that are not in accordance with PFRS Recognizing revenue that should be deferred

Misappropriation of Assets: Withholding Cash Receipts 1. Skimming This refers to the act of withholding cash receipts without recording them. Detection of unrecorded cash receipts is very difficult; however, unexplained changes in the gross profit percentage or sales volume may indicate that cash receipts have been withheld. 2. Lapping This technique is used to conceal the fact that cash has been abstracted; the shortage in one customer’s account is covered with a subsequent payment made by another customer. An employee who has access to cash receipts and maintains accounts receivable can engage in lapping. Routine testing of details of collections compared with validated bank deposit slips should uncover this fraud. 3. Kitting This is another technique used to cover cash shortage or to inflate cash balance. Kiting involves counting the cash twice by using the float in the banking system. (Float is the gap between the time the check is deposited or added to an account and the time the check clears or is deducted from the account it was written on). Analyzing and verifying cash transfers during the days surrounding year-end should reveal this type of fraud.

ACQUISITIONS AND PAYMENTS CYCLE 1. Errors in the Acquisition and payments Cycle

The following may occur in the acquisition and payments cycle:  Failing to record a purchase in the proper period (cutoff errors)  Recording goods accepted on consignment as a purchase  Misclassifying purchases of assets and expenses  Failing to record a cash payment  Recording a payment twice  Failing to record prepaid expenses as assets Entities normally design controls to prevent these errors from occurring or to detect errors if they do occur. When such controls exist, auditors test the controls to assess their effectiveness. If the controls are not effective, auditors should perform substantive tests to determine that the financial statements do not contain material misstatements that arose because of possible errors. 2. Frauds in the Acquisition and Payments Cycle a. Paying for Fictitious Purchases This involves the perpetrator creating a fictitious invoice (and sometimes a receiving report, purchase order and so forth) and processing the invoice for payment. Alternatively, the perpetrator can pay the invoice twice. b. Receiving Kickbacks In this scheme, a purchasing agent may agree with a vendor to receive a kickback (refund payable to the purchasing person on goods or services acquired from the vendor). c. Purchasing Goods for Personal Use Goods or services for personal use may be purchased by executive or purchasing agents and charged to the company’s account. To execute such a purchase, the perpetrator must have access to blank receiving reports and purchase approvals or must connive with another employee. Fraud involving the purchase of goods for personal use is more likely to go unnoticed when perpetual records are not maintained.

III.

PAYROLL AND PERSONAL CYCLE Historically, errors and irregularities involving payroll have been reported to occur frequently and are largely undetected.

1. Errors The most errors can occur in the payroll and personnel cycle are: a) Paying employees at the wrong rate. b) Paying employees for more hours than they worked. c) Charging payroll expense to the wrong accounts; and d) Keeping terminated employees on the payroll. Good internal control can be established to prevent these errors from occurring and to detect them if they do occur. 2. Frauds involving Payroll The major payroll-related frauds include; a. Fictitious Employees Adding fictitious employees to the payroll is one of the most common defalcations. Detecting fictitious employees on the payroll is very difficult; but auditors do sometimes perform a surprise payoff as a deterrent to this form of defalcation. Alternatively, the auditor may turn the check distribution over to an official not associated with preparing payroll, signing checks, or supervising workers. Personnel files and the employees’ completed time cards and time tickets may also be examined to substantiate the existence of absent employees. b. Excess Payments to Employees Increasing the rate above the approved or paying employees for more hours that they worked are the most common ways of paying employees more than they are entitled to receive. These practices can be substantially reduced by requiring personnel department officials to authorize changes in pay rates and by monitoring total hours worked and paid for. Analytical procedures that focus on cost per unit of actual production can also be helpful in detecting excess payments to employees. c. Failure to Record Payroll Companies having difficulty meeting profit targets or not-for-profit entities having difficulty managing costs and expenses might fail to record a payroll. The omission of payroll can be difficult to hide unless a similar amount of revenues or receipts has been omitted. Analytical procedures can be performed to test the reasonableness of payroll cost. d. Inappropriate Assignment of Labor Costs to Inventory A company having difficulty meeting profit targets might assign to inventory labor cost that should have been charged to expense. Analytical procedures such as comparing costs incurred to budgeted cost and verification of valuation of inventory are some of the useful techniques in detecting such fraud....