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PRACTICAL ERROR OR FRAUD ANALYSIS FOR FINANCIAL STATEMENTS

PRACTICAL ERROR OR FRAUD ANALYSIS FOR FINANCIAL STATEMENTS

Learning Objectives:

 I. Comparative Figures from Prior Periods

II. Unusual change in amount

III. New Account Types or Transactions

IV. Relevant Ratios Analysis

V. Analytical Procedures

………………………………………………..

In practice, draft financial statements are submitted by subordinates to their managers, these draft financial statements may be checked the following steps to identify errors or sometime fraud:

I. Comparative Figures From Previous Periods

The comparative financial statements are the way to analyze and compare particular financial statements with prior periods, for example, if company prepares monthly income statement and balance sheet for May 2017, so financial managers may want to compare these financial statements prepared on April 2017 or March 2017 respectively.

These processes will reveal the following concepts:

  • Identify trends in the financial figures in financial statements
  • Evaluate performance of business
  • Easy to identify omitting transactions, e.g. salary expenses are not recorded for May 2017 yet.
  • Easy to identify wrong classification, e.g. marketing expenses may be recorded as administration expense.
  • Significant changes of amount may be identified, etc.

In practice, we need to know nature of the following transactions:

  • Fixed transactions, e.g. salary expenses, pure discount loan, interest-only loan etc.
  • Variable transactions
  • Semi transactions
  • Correlation transactions.

II. Unusual Change in Amount

 In practice, financial statement preparers will examine unusual or abnormal change of financial transactions such as asset, liability, equity, revenue and expenses.

For example, transactions increase or decrease beyond 100%.

III. New Account Types or Transactions

 New account types or transactions of asset, liability, revenue and expenses should be checked and quested for any explanation.

For example, monthly statement of financial position for April 2017 has only current liabilities, but monthly report for May 2017 includes loan from bank, so we should know interest rate, amount of loan, payment and loan conditions.

IV. Relevant Ratios Analysis

 In practice, we need to know correlation transactions. Especially sale and cost of sale are close relationship, so comparative ratios (cost of sale/sale) may be important.

V. Analytical Procedures

 Analytical procedures can be defined as the evaluation of financial information by studying the relationships between both financial data and non-financial data.

They also include comparison of financial information with prior periods, budgets and forecasts and similar industries consideration of predictable relationships such as the relationship of purchases to sales, and payroll costs to the number of employees.

 Let’s practice with the following example:

Top Trading Group Co.,Ltd is merchandising company, and company has two major products. The following comparative income statements are here.

Currently financial statements are unreliable, so old financial manager resigned for his position. You are new financial manager for Top Trading Group Co.,Ltd, and your accountants prepare financial statements to review, but you suspect that financial statements may have errors or frauds during review.

 

Top Trading Group Co.,Ltd

Comparative Income Statement

For 2015
 November December
 Sale:
Sale from Product 1       200,000 220,000
Sale from Product 2       100,000 110,000
 Sale from Other Products       160,000 176,000
Total Sale       460,000 506,000
 Cost of Goods Sold:
Product 1-COGS       140,000 151,800
 Product 2-COGS 80,000 99,000
 Other Products-COGS       144,000  123,200
 Total COGS   364,000  374,000
 Gross Profit  96,000 132,000
 Other Income – Rental Income       2,000     3,000
 Total Expense:
Advertising           4,000     4,400
Salary         10,000     9,000
Office supply              400        600
Electricity              500    2,000
Water supply              300       350
Rental          14,000  18,000
Telephone and Internet              800      880
Depreciation           1,200   1,400
Interest expense…………………………            1,400   1,600
Other expense              740      814
Total Expense         33,340  39,044
Net Income/(loss)        64,660   95,956

During period, company bought fixed assets more. 

Required:

According to your professional judgment, identify possible frauds or errors for comparative income statements if any with reasonable explanation for any suspicion.

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