FRAUD RISK FACTORS & ERRORS

While reviewing the audit files of four different clients you confronted the following situations:

1. The Board of Directors of the company has recently appointed Mr. Smart as new Chief executive whose
remuneration is mostly based on efficiency bonus and stock options.
2. Mr. Smart is reputed as a seasoned business executive and has been a very good friend of the Chairman of the
audit committee.
3. Since his joining he has proved to be the main decision maker and the Board appears to be relying considerably
on Mr. Smart and less interested in day to day operations of the company.
4. Board’s main concern is now the growth in net earnings estimated for the next year, which Mr. Smart strongly
believes, will be 30% at the minimum.
5. There are number of instances of lack of segregation of duties and Mr. Smart being conscious, has allowed the
situation to continue.
6. There is a big lay off plan in place and employees are expecting such plan although it has been kept as top secret.
This lay off will help the company to achieve higher growth earnings.
7. During the initial meeting the client (IL) has informed that:
 IL has achieved a growth of 60% as compared to the growth target of 30% set for the financial year ended
30 June 2016 and the board of directors are considering to distribute 25% of the profit to thr
management staff as performance bonus.
 One of the competitors has shown its willingness to acquire IL.
8. Due to tough competition in the market, the company has been unable to increase the prices of its product since
last 5 years.
9. Addition to intangible assets, amounting to Rs. 500 million include research cost of Rs. 10 million which is duly
supported by invoices from suppliers.
10. During the last 3 years, the CE and higher management has been earning handsome bonuses, based on
profitability of the company.
11. Physical stock take on 31 December 2014 included goods sold but not dispatched amounting to Rs. 52 million.
The delivering of goods was stopped on the request of a distributor. Upto 20 January 2015, the distributor has
taken delivery of goods amounting to Rs. 2 million.
12. The quantity of material scrapped during the year is materially different from the quantity of scrap sold. The
company’s record shows nil balance both at the beginning and at the close of the year. No reconciliation for the
difference has been provided by the company.
13. Sales of the year have increased by 7% over the previous year. However, it has been noted that sales in the last
two weeks of June 2010 have been exceptionally high and represent 15% of the annual sale. The audit working
papers carry the following observations in respect of the above:
 70% of the sales in last two weeks of June were made to two new customers whose credit assessment
has not been formally documented.
 A significant portion of the goods sold to the above referred customers were returned in the first week of
July 2010; and
 Management bonuses are linked to the operating performance of the company.
14. During the year, entity purchased a machine for Rs. 25 million. The payment voucher is duly supported by the
invoice from the supplier. However, the fixed assets schedule provided by the client shows the amount
capitalized as Rs. 2.5 million. Depreciation has been charged on this amount. The difference of Rs. 22.5 million is
appearing in the Bank reconciliation Statement.
15. An entity was previously exporting all its production under the brand name of ‘WEARABLES’. However, it has
been facing the issue of decline in export orders and therefore has decided to start focusing on the local market.
Accordingly, it has made an agreement with other entity, according to which that entity’s products would be sold
to other entity who would market them through other entity’s retail outlets spread throughout Pakistan. A
director of an entity holds major shareholdings in other entity.
16. Two of the directors of an entity (A) holding 16% and 13% shares in an entity (A) have informed the Board that
they intend to sell their entire shareholding in an entity (A) in order to concentrate on some of their businesses.
17. While discussing some of the internal control deficiencies in the payroll processing department, which were
raised in the previous year’s management letter, the CFO has informed that the matter has been referred to the
internal audit department but is pending because of the illness of the CIA.