Evaluation of Comptronix Corporation: Identifying Inherent Risk and Control Risk Factors Essay

1. Professional scrutiniseing standards exhibit the size up put on the line position, which is used to regularize the nature, timing, and extent of audit procedures. Describe the components of the model and discuss how changes in each component affect the listeners need for evidence. The audit pretend model is used to determine the nature, timing, and extent of substantive audit procedures. The components of audit risk model usu solelyy stated as follows DR = AR/(IR x CR)Where DR = detection risk AR = audit risk IR = inbred risk CR = control risk Detection Risk auditors procedures will lead them to conclude that a fiscal tilt assertion is not materially misstated when in fact such misstatement does exist. If auditors want to decrease DR, they had better collect more evidence and be fare sure the validity of evidence. Audit Risk auditors may unknowingly fail to appropriately modify their opinion on monetary statements that are materially misstated. If AR should be keep in low level, which means the other risks also should be low.Inherent Risk The risk of material misstatement of a financial statement assertion, assuming there were no related controls. As built-in risk increases, PDR decreases, which in turn increases the auditors need for stronger evidence. authorization risk The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by inherent control. If the strength of internal control is assessed as decreasing, the auditor should pay more attention to control risks.2. One of the components of the audit risk model is inherent risk. Describe typical factors that auditors evaluate when assessing inherent risk. With the benefit of hindsight, what inherent risk factors were present during the audits of the 1989 through 1992 Comptronix financial statements? Inherent risk is a measure of the auditors assessment of the susceptibility of an assertion to a material misstatement assuming the re are no related internal controls. roughly believe that inherent risk would be greater for some assertions and related account base on some conditions as follows Complex calculations rather than simple calculations.Non- usage rather than routine transactions.Subjective data rather than objective data.More importantly is that inherent risk is always be effected by external factors as follows Changes in economic environmentInsufficient capital to continue operationsTechnological improvements.Transactions with related parties.Susceptibility of assets to misappropriation.The inherent risk factors present during the 1989 through 1992 financial statement audits as follows Loss of Key Customer Comptronix scattered a key guest to SCI after(prenominal) the overt offering of stock. Once the company lost their a key customer, Management relieve oneself a strong motivation manipulate sales and direct performance to satisfy investor expectations because the loss of a key customer put too much pressure on focussing to meet the requirements of external users. Public Offering of Stock After Comptronix make its public offering of stock , they have the pressure which push the management to manipulate operating performance too meet the expectations from the external users.Technological Improvement Comptronix is a manufacture company which main products are circuit get on withs and the circuit boards development depend on technological improvement. The technological improvement has a negative push on operating performance. Pressures from a new star Company By the primary year of the fraud (1989), Comptronix became a new company which can hold more than 1,800 employees in little than a decade , and at same time, the company expanded its the size of the company in three different locations. The rapid development of company made the management adjusted their operations instead of monitoring company operations.Estimation of Accounts The high inherent risk accounts include Accounts receiv sufficient/ payable, inventory, and property, plant, and equipment. But all the accounts computation is based on estimation which led the numbers are very unreliable and subjective. Cash Flow Pressures Comptronix suffered net losings from 1986. Until the company attracted a venture capitalist, the company was able to generate strong sales and win. Prior to 1989, Comptronix had generated only deuce consecutive years of profit after several years of net losses. cash flow of financial statement cannot cover many years of recurring losses.The management has motives to make up operating accounts to look perfect to attract moreinvestors. 3. Another component of the audit risk model is control risk. Describe the five components of internal control. What characteristics of Comptronixs internal control increased control risk for the audits of the 1989-1992 closing financial statements?Five components of control risk are control environment, risk assessment, control activities, information and communication, and monitoring. Control environment set the tone of an organization by influencing the control consciousness of people. Risk assessment is managements process for identifying, analyzing, and responding to the risks. Control activities are policies and procedures that booster ensure that managements directives are carried out. Information is needed at all levels of an organization to assist management in meeting the organizations objectives.Monitoring of controls is a process to assess the quality of internal control performance over time. The information and communication is seriously weak in that he three executive directors were able to perpetrate the fraud by bypassing the existing accounting system. They could record the fictitious entries manually and other employees were excluded from the manipulations to minimize the samelihood of the fraud world discovered.Besides, the weak control activity and monitoring is represented by the f act that Mr. Shifflett or Mr. Medlin could approve payments based solely on an invoice. Therefore, the fraud team was able to bypass internal controls over cash disbursements.Internal controls were also insufficient to detect the manipulation of sales and accounts receivable. Mr. Medlin had the office to access the shipping department system.4. The board of music directors, and its audit direction, can be an effective corporate governance mechanism. Discuss the pros and cons of allowing inside directors to sere on the board. Describe typical responsibilities of audit committees.What strengths or weaknesses were present related to Comptronixs board of directors and audit committee?As shareholders have limited access to the sufficient information, they are hard to monitor the daily transactions and management. They would delegate the responsibilities to the board of directors. Then, board of directors require inside directors to can sufficient information in order to make decision s those are in the maximum profits of shareholders. However, if the inside directors have improper purposes, its easily to be a manipulation tool for management.Audit committee is responsible for ensuring that the companys financial statements and reports are accurate and use fair and reasonable estimates. More specifically, it is charged with overseeing the financial reporting and disclosure process, monitoring choice of accounting policies and principles, overseeing hiring, performance and independency of the external auditors, oversight of regulatory compliance, monitoring the internal control process, overseeing the performance of the internal audit function, and discussing risk management policies and practices with management.The control environment is significantly influenced by the intensity level of its board of directors or its audit committee. Factors that bear on the effectiveness of the board or audit committee include the extent of its independence from management, th e gravel and stature of its members. However, among the seven individuals in Comptronix board of directors, five members are either inside directors or directors had closedown affiliations with management.In addition, the primary responsibility of the board of directors is to defend the shareholders assets and ensure they receive a decent return on their investment. Board members act as trustees of the organizations assets and must exercise collectible practical application to oversee that the organization is well managed and that its financial situation remains sound. But the composition of Comptronixs board of directors obviously lacks objectivity.A qualifying audit committee should be composed of independent directors who are not officers or employees of the organization and who do not have other relationships that impair independence. However, The audit committee ofComptronix is made up two outside directors and one gray director, which would inevitably impair the independe nce.Whats more, to qualify, the committee must be composed of outside director with at least one qualifying as a financial expert. Nevertheless, for Comptronix Corporation, there is no indication of whether any of these individuals had accounting or financial reporting backgrounds. Lastly, the audit committee met only twice during 1991, it was not efficiently and sufficiently to monitor and oversee the financial reporting.5. Public companies must file quarterly financial statements in Form 10-Qs, that have been reviewed by the companys external auditor. Briefly describe the key requirements of Auditing Standards (AU) office 722, Interim Financial Statements. Why wouldnt all companies (public and private) engage their auditors to perform timely reviews of interim financial statements?The term interim financial information means financial information or statements covering a period less than a full year or for a 12-month period ending on a date other than the entitys fiscal year end. A review consists principally of performing analytical procedures and making inquiries of persons responsible for financial and accounting matters, and does not contemplate (a) test of accounting records through inspection, observation, or confirmation (b) tests of controls to evaluate their effectiveness (c) the obtain net of corroborating evidence in response to inquiries or (d) the performance of certain other procedures ordinarily performed in an audit.The decision to have a review engagement is a joint decision of the knob and auditor. So a review would be performed when the benefits to the auditor and to the client exceed the costs to both parties. In general, firms with high complexity are more likely to be reviewed than firms with low complexity. Firms with high growth opportunities a less likely to be reviewed than those with low growth opportunities for they may be associated with higher information and litigation risks. And its also about the firms audit assurance and a mends needs.6. Describe whether you think Comptronixs executive team was inherently dishonest from the beginning. How is it possible for otherwise honest people to become involved in frauds like the one at Comptronix?We dont think Comptronixs executive team was inherently dishonest from the beginning. In opposite, we think there are two main reasons for the company committed the fraud.The first is its weak internal control.First comes to the companys board of director. The board of directors is responsible for overseeing the actions of management. Factors that bear on the effectiveness of the board include the extent of its independence from management, the experience and stature of its members, the extent to which it raises and pursues difficult questions with management, and its interaction with the internal and external auditors.the audit committee of the board of directors should be composed of independent directors who are not officers or employees of the organization and who d o not have other relationships that impair independence. In addition, the audit committee should have one or more members who have financial reporting expertise.However, Comptronixs board of directors consist of the CEO and the COO of the company, And two of the other five directors who had close affiliations with management, one served as the companys outside general legal counsel and the other who served as vice president of manufacturing for a significant customer of Comptronix, and one of the remaining outside directors who was a partner in the venture capital firm that owned 574,978 shares (5.3%) of Comptronixs common stock, the second outside director who was the vice chairman and CEO of the local bank originally loaning money to the company, and the third outside director who was president of an international components supplier based in Taiwan.And there was no indication of whether any of these individuals had accounting or financial reporting backgrounds. 28.6% of the board consisted of inside directors. And even all of the board of directors refuse the independence andeffectiveness of the formation of the board of directors. The interest relationship with the company increased the potential risk for the management to commit fraud.The second reason is the grand pressure of harsh competition for the companies in the industry. The fraud was motivated by the loss of a key customer in 1989 to the three executives former employer, SCI. Since the first manipulation of the financial statement, they were forced to manipulate the other years and evidences to hide the manipulation, which created a vicious circle.In conclusion, the weak internal control system provided a good environment for the commission of fraud. The huge pressure of the company brought the motivation of the fraud. Both of them played important roles for the honest people to become involved in frauds.7. Auditing Standards (AU) Section 316, Consideration of Fraud in a Financial Statement Aud it, notes that three conditions are generally present when fraud occurs. Research the authoritative standards for auditors and provide a brief summary of each of the three fraud conditions. Additionally, provide an example from the Comptronix fraud of each of the three fraud conditions.(1) Three fraud conditionsFirst, management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. Second, circumstances existfor example, the absence of controls, ineffective controls, or the ability of management to reverse controlsthat provide an opportunity for a fraud to be perpetrated. Third, those involved are able to rationalize committing a fraudulent act. Some individuals possess an attitude, character, or set of ethical values that allow them to knowingly and intentionally commit a dishonest act.(2) ExamplesThe incentive for top company executive to do fraud is that after the company went public, the company needed an increasing number for prof it on the income statement, to attract more investors and make the stock expenditure higher and higher.One of the opportunities for fraud perpetrated in Comptronix is that their internal controls were so insufficient. The three executives had so many authorities to get access to various accounts. They can get control of both checks and accounts payable, which enable them to make fake equipment purchasing recording.Because Comptronixs quarterly filings were unaudited, the executives were successful in manipulating quarterly financial statements. After they successfully manipulated 1989 year-end sales and receivables, they thought their performance may not be discovered by external auditors and SEC, so they began recording fictitious quarterly sales frequently.8. Auditing Standards Section 316, Consideration of Fraud in a Financial Statement Audit, notes that there is a possibility that management override of controls could occur in every audit and accordingly, the auditor should inc lude audit procedures in every audit to address that risk.a. What do you think is meant by the term management override?Management override of internal controls is the intervention by managers in handling financial information and making decisions contrary to internal control policy. Managers may think they have the ability to operate outside of the internal controls, but this is not true.b. provide two examples of where management override of controls occurred in the Comptronix fraud.For example, Mr. Medilin, as controller and treasurer, has the authorization to manipulate both sales documents and accounts receivable documents. Thus he can enter bogus sales into the accounting system then make fake accountsreceivable to hyperbolise the companys earnings.Moreover, in order to overstate the equipment and accounts payable, the three company executives cut fake checks to the bogus accounts payable vendors associated with the fake purchases of equipment. However, the check preparing an d recording of equipment purchases jobs should be distributed to different staff. Handling these two jobs at the same time by same executives provide them opportunity to make overstated recording of equipment purchasing.c. Research AU Section 316 to identify the three required auditor responses to push address the risk of management override of internal controls.Three required auditor responses to further address the risk of management override (1) Examining journal entries and other adjustments for evidence of possible material misstatement due to fraud. (2) Reviewing accounting estimates for biases that could result in material misstatement due to fraud. (3) Evaluating the business rationale for significant unusual transactions.