Accounting and Finance Foundations

Unit 13

Accounting and Finance Foundations Unit 13: Auditing 1000

Auditing

Chapter 30

Student Guide

Fraud

Auditors understand that mistakes happen. That’s why minor errors and approximations are expected

and accepted—even within business financial records. An employee might enter an expense in the wrong

account accidentally, the allowance for bad debt might be over- or under-estimated, or assets might be

recorded at their market value rather than their cost. At the same time, though, auditors must exercise pro-

fessional skepticism. In other words, they look for reasonable assurance that the financial data are accurate

and aren’t the result of fraud.

What is fraud? It’s any deception purposely carried out to secure unfair or unlawful gain and typically takes

one of two forms—one that involves managers and owners and another that involves non-management

employees.

Many large corporations—along with their top business managers and owners—became famous in the

early 2000s for their fraudulent activities. Take Enron, for example, which was the seventh largest com-

pany in the U.S. prior to its collapse. In the late 1990s and into the 2000s, Enron accumulated hundreds

of millions of dollars in debt. To keep analysts and the company’s investors from learning about the debt,

Enron executives omitted the debt from their financial statements and reported revenue that didn’t actu-

ally exist. In other words, they committed fraud to make the corporation look much more successful than

it really was. But, the Securities and Exchange Commission (SEC) caught on to Enron’s act. The company

fell apart—and took Arthur Andersen (a highly successful accounting firm that was responsible for auditing

Enron’s books) with it.

WorldCom is another corporation that fell victim to fraud early in the 21st Century—and office supplies

played a big role in the scandal. Ordinarily, office supplies are recorded as operating expenses for the

fiscal year in which they were purchased. However, WorldCom executives chose to view the supplies as

investments in the company and therefore recorded them over several years. By doing so, they were able

to report much, much higher profits than actually existed. Essentially, WorldCom executives approved the

development of fraudulent financial statements to cover up the fact that the business was in decline. When

the executives’ dishonest activities were discovered, WorldCom collapsed, and its stock price fell from over

$60 to less than $0.20 per share.

Business owners and managers aren’t the only ones to commit fraud. Regular employees are sometimes

guilty of “cooking the books,” too. If an employee is stealing money, inventory, or equipment from his/her

employer, for example, s/he might omit, change, or add certain transactions in company records to conceal

her/his crimes.

Unfortunately, this type of fraud isn’t all that uncommon. For instance, in February 2013, a longtime em-

ployee of the Longview (Washington) YMCA admitted to stealing more than $180,000 from her employer

over a five-year timespan. As the YMCA’s bookkeeper, the woman had access to the organization’s financial

records, which she altered to cover up her theft. (See http://tdn.com/news/local/bookkeeper-accused-of-

stealing-from-ymca/article_91a53444-811d-11e2-bbc3-001a4bcf887a.html for more information about

the fraud.) Here’s where internal controls come in: More effective internal controls could probably have

prevented the crime from occurring.

Lesson 30.4 The Audit Process—

Conducting Analytical Procedures (cont’d)