Biasura, Jhazreel Mae N.

BSA 2B

REVIEW QUESTIONS AND EXERCISES

Questions

1. Distinguish between the terms errors and fraud.

The main difference between the two terms lies in the intention of the parties involve. When we say
error, it is an error which is an unintentional mistake in the financial statements. Fraud, on the other
hand, is intentional and usually involves the deliberate concealment of the facts. This is precisely the
differentiating factor between fraud and error, whether the underlying measure that causes
misstatement in financial statements is intentional or unintentional.

2. Distinguish between fraudulent financial reporting and misappropriation of assets. Discuss the
likely difference between these two types of fraud on the fair presentation of financial statements.

The major distinguishing factor that determines between the types of misstatement is the people
participating in the event. Financial reporting that contains fraud is management fraud, while
misappropriation of asset is employee fraud.

Misappropriation of assets usually occurs because internal controls are not enough. Also, violation of
existing controls maybe a reason at some instances. With that, the perfect way to prevent this kind of
misstatement is to have an effective and adequate internal controls. Often, the theft of assets in pesos
is relatively small and does not affect the fair presentation of financial statements. On the other hand,
the second type of misstatement which contains fraud, is basically difficult to detect because one or
more senior executives can revoke internal controls.

3. Define fraud, and explain the two types of misstatements that are relevant to auditor's
consideration of fraud.

Firstly ,fraud refers to the willful actions of one or more individuals among the management. In other
words, the people involved are those people responsible for running the company, employees, or third
parties who use fraud to gain an unfair or illegal advantage. We know that there are two types of
misstatements namely fraudulent financial statements involving intentional omissions or omissions in
amounts or disclosures in financial statements to mislead users. This is also known as management
fraud. While the second variation is the misappropriation of assets, it is the theft of company assets by
an employee. Employee fraud is an another term for this type.

4. What are the most common approaches that perpetrators use to commit fraudulent financial
reporting?

The most common ways in which fraudulent financial reporting can take place include:

 Manipulation, falsification or alteration of accounting records or supporting documents

  Omission or misrepresentation of events, transactions or other significant information
 Intentional misapplication of accounting principles.

5. You are asked to be interviewed by a student newspaper regarding the nature of accounting fraud.
The reporter says, "As I understand it, asset misappropriations are more likely to be found are more
likely to be found in small organizations, but not in larger organizations. On the other hand,
fraudulent financial reporting is more likely to be found in larger organizations." How would you
respond to the reporter's observation?

Rather, this presumption or conjecture is based on the fact that misstatements resulting from
fraudulent financial reporting result in an increase in the share price of large companies rather than
small businesses, which may be partnerships or sole proprietorships where there is no share price. And
small businesses can easily misuse assets if their owners trust them to handle the money. However, I
think both are possible in any business once the culprit gets into the business and has the opportunity to
do so. I advise companies to remain vigilant about financial assets and reports. The company must also
have good human resource management so that every member employed has confidence and is in line
with the company's goals.

6. The fraud triangle identifies incentives, opportunities, The and rationalizations as the three
elements associated with most frauds. Describe how each of these elements is necessary for fraud to
occur.

Incentives

- The greater the incentive or pressure, the more likely someone will be able to rationalize acceptance of
fraud.

Opportunities

- There are circumstances such as lack of control, ineffective controls, or management's ability to replace
controls that allow fraud.

Rationalization

- Individuals have the potential to streamline fraud. Some people have attitudes, characters, or a set of
ethical values that allow them to knowingly and deliberately commit dishonest acts. But honest people
can also commit fraud in other ways in an environment that is quite stressful for them.

7. If one of the three elements of the fraud triangle is not present, can fraud still be perpetrated?
Explain.

Base from the learnings in the theory, all three elements must be present for fraud to happen in the
workplace. All of these elements are involved in updating a scam. Incentive or pressure becomes the
motive of the perpetrator, it can be in the form of personal gain and greed. Fraud opportunities are
needed because in this case they will take advantage of all the weaknesses that exist in controlling
business processes. Therefore, companies need to have strong internal control or complexity in every
transaction so that not every employee has the opportunity even though they are motivated. However,
rationalization serves as a way of thinking that the fraud committed will be justified. This way of thinking
will be the imposter's position and a justification for his actions. The three of them have different roles
in motivating the perpetrator to commit fraud and this makes it equally important in the situation.

8. ldentify factors (red flags) that would be strong indicators of opportunities to commit fraud.

Some of the opportunities to commit fraud that the top management should consider include the
following:

 Significant related-party transactions

 A company’s industry position, such as the ability to dictate terms or conditions to suppliers or
customers that might allow individuals to structure fraudulent transactions
 Management’s inconsistency involving subjective judgements regarding assets or accounting
estimates
 Simple transactions that are made to understand transactions, such as financial derivatives or
special-purpose entities
 Ineffective monitoring of management by the board
 Complex organizational structure
 Weak internal controls

9.Is the ability to rationalize the fraud an important aspect to consider when analyzing a potentially
fraudulent situation? What are some of the common rationalizations used by fraud perpetrators?

Rationalization is an important aspect to consider a potentially fraudulent situation because an auditor

that thinks critically will easily identify or detect different justifications a perpetrator may commit from
its rationalization and the auditor could be better prepared and equipped to prevent the fraudulent act.

Some of the common rationalizations used by fraud perpetrators include the following:

For asset misappropriation, personal rationalizations often revolve around mistreatment by the
company or a sense of entitlement (such as, "the company owes me!") by the individual perpetrating
the fraud. Following are some common rationalizations for asset misappropriation:

Fraud is justified to save a family member or loved one from one financial crisis.

We will lose everything (family, home, car and so on) if we don't take the money.

No help is available from outside.

This is "borrowing", and we intend to pay the stolen money back at some point.

Something is owed by the company because others are treated better.

We simply do not care about the consequences of our actions or of accepted notions of decency and
trust; we are for ourselves.

For fraudulent financial reporting, the rationalization can range from "saving

the company" to personal greed, and may include the following:

This is one-time thing to get us through the current crisis and survive until things get better.

Everybody cheats on the financial statements a little; we are just playing the same game.
We will be in violation of all of our debt covenants unless we find a way to get this debt off the
financial statements.

We need a higher stock price to acquire company XYZ, or to keep our employees through stock
options, and so forth.

10. Define and illustrate kiting. What controls should the client institute to prevent it?

To define what is meant by kiting, this is carried out by transfer at the end of the year from one bank
account to another bank account. Deposits are recorded in the second account, but payments are only
recorded in the first departmental account in the following business period. Client agencies must have a
referral plan or bank transfer schedule to prevent kiting. The table shows a breakdown of all transfers to
and from the customer's bank and between the customer's banks. Withdrawal and deposit dates must
be recorded in the same reporting period to avoid double counting cash.

Exercise 1

The fraud triangle asserts that the following three factors must exist for a person to commit fraud:

A. Opportunity B. Pressure C. Rationalization

identify the fraud risk factor (A, B or C) in each of the following situations:

A I. The business has no cameras or security devices at its warehouse.

B 2. Managers are expected to grow business or be fired.

C 3. A worker sees other employees regularly take inventory for personal use.

A 4. No one matches the cash in the register to receipts when shifts end.

B 5. Officers are expected to show rising income or risk dismissal.

C 6. A worker feels that fellow employees are not honest.

Exercise 2 E

Each of the following scenarios is based on facts in an actual fraud. Categorize each scenario as
primarily indicating (1) an incentive to commit fraud, (2) an opportunity to commit fraud, or (3) a
rationalization for committing fraud. Also state your reasoning for each scenario.

a. There was intense pressure to keep the corporation’s stock from declining further. This pressure
came from investors, analysts, and the CEO, whose financial well-being was significantly dependent
on the corporation’s stock price.

What I can conclude from this scenario is an incentive to commit fraud. Keeping the stock price at a
good price is undoubtedly valid and normal, but holding back the pressure of investors and CEOs on
share prices for their well-being is somehow an act that is intolerable. Stock prices is very significant to
the CEO and other investors, because what is essential for them is their financial security. This act
equates to lack of integrity

b. A group of top level management was compensated (mostly in the form of stock options)

well in excess of what would be considered normal for their positions in this industry.

Also, this kind of scenario is categorized as indicating an incentive to commit fraud for the reason that
giving more cash from stock options to a group of top managers is a bigger incentive to make unjustiable
actions. We cannot deny the fact that this might push people to do wrongful actions since it may serve
as a drive for them to do things they don't normally do.

c. Top management of the company closely guards internal financial information, to the extent that
even some employees on a “need to know basis” are denied full access.

Based from this scenario I highly think of this as an opportunity to commit of fraud. The act of denying
accessibility regarding internal financial information equals to the possibility or opportunity to commit
of fraud. Because of employees ‘ lack of access, this may pave the way for top management to commit
such a wrongful act.

d. Managing specific financial ratios is very important to the company, and both management and
analysts are keenly observant of variability in key ratios. Key ratios for the company changed very
little even though the ratios for overall industry were quite volatile during the time period.

They may be no unethical action that exists in this situation but this highly represents an opportunity to
commit fraud. Doubtlessly, a company’s situation are not always stable and this is normal. However, we
cannot also neglect the fact that it can pave way for the management to commit fraud in order to make
their financial ratios in a good state.

e. In an effort to reduce certain accrued expenses to meet budget targets, the CFO directs the general
accounting department to reallocate a division’s expenses by a significant amount. The general
accounting department refuses to acquiesce to the request, but the journal entry is made through the
corporate office. An accountant in the general accounting department is uncomfortable with the
journal entries required to reallocate divisional expenses. He brings his concerns to the CFO, who
assures him that everything will be fine and that the entries are necessary. The accountant considers
resigning, but he does not have another job lined up and is worried about supporting his family.
Therefore, he never voices his concerns to either the internal or external auditors.

Definitely, this situation represents rationalizing to commit fraud as accountants are worried about what
the CFO is devising. The accountant have voiced out his concern but still didn't follow it because he
believed he had no other job and was worried about the welfare of his family if he lost his job. Because
of this conflicting situation, he thought of resigning but on the other hand he also think that this is
justifiable for his survival.

f. Accounting records were either nonexistent or in a state of such disorganization that significant
effort was required to locate or compile them.
This highly implies a scenario that shows opportunity to commit fraud because of the fact that the
records are either non-existent or disorganized. This actually means there was an attempt to hide the
error from being audited. The major reasons in this part are probably because of not stable
organizational structure and weak internal controls in this scenario.

Exercise 3

Answer

Anyone who has the authority to certify a report that is required under this code and willfully certifies it
despite the fact that it contains incomplete, inaccurate, false or misleading information or statements,
will be punished with a fine of PHP 20,000 to PHP 200,000. Also, if improper public certification is
harmful to the public, the examiner, auditor or the responsible person can be fined between 40,000 and
400,000 PHP. The person responsible for fraud is the one who made approval of the financial
statements. One of the SFC's reporting obligations for corporation is annual financial statements audited
by an independent auditor. If the total assets or total liabilities of the company are less than 600,000,
the annual financial statements will be confirmed by the cashier or chief financial officer. Those
responsible for managing and compiling the company's annual accounts must bear the losses, even if
they go bankrupt. Their own wealth must have been used to justify the damage or loss. On the other
hand, the examiner must be found not guilty, but if the committee determines that improper
certification is detrimental or detrimental to the public, the responsible examiner can also be fined PHP
40,000 to 400,000.

The above explanation and provision is found in Section 2 of Republic Act 11232 otherwise known as the
"Revised corporation code of the Philippines" .

Multiple choice

1. B
2. B
3. B
4. E