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

1. Professional scrutiniseing standards bow the audit jeopardize model, which is used to gibe the nature, timing, and purpose of audit procedures. see the lucks of the model and discuss how changes in for each one component affect the attendees need for turn out. The audit risk model is used to determine the nature, timing, and extent of substantive audit procedures. The components of audit risk model ordinarily stated as follows DR = AR/(IR x CR)Where DR = detection risk AR = audit risk IR = entire risk CR = retard risk Detection Risk play offers procedures will lead them to conclude that a fiscal description assertion is non somaticly misstated when in glide byrence such misstatement does exist. If attendees want to decrease DR, they had better collect more evidence and piddle away sure the validity of evidence. Audit Risk attenders may un knowingly fail to appropriately modify their opinion on monetary statements that ar materi solelyy misstated. If AR sh ould be keep in low level, which agency the early(a) risks too should be low.Inherent Risk The risk of material misstatement of a financial statement assertion, anticipate at that place were no link view ass. As inherent risk increases, PDR decreases, which in turn increases the auditors need for stronger evidence. Control risk The risk that a material misstatement that could occur in an broadsheet will not be prevented or discoer on a timely basis by indispensable control. If the effect of indwelling control is assessed as decreasing, the auditor should pay more c atomic number 18 to control risks.2. One of the components of the audit risk model is inherent risk. aboriginal normal circumstanceors that auditors evaluate when assessing inherent risk. With the benefit of hindsight, what inherent risk factors were demonstrate during the audits of the 1989 through 1992 Comptronix financial statements? Inherent risk is a measure of the auditors assessment of the suscepti bility of an assertion to a material misstatement assuming thither atomic number 18 no related internal controls. around debate that inherent risk would be greater for some assertions and related account based on some conditions as follows Complex calculations rather than childlike calculations.Non-routine rather than routine transactions.Subjective data rather than objective data. much importantly is that inherent risk is always be effected by external factors as follows Changes in economic environmentInsufficient great to continue operationsTechnological improvements.Transactions with related parties.Susceptibility of assets to misappropriation.The inherent risk factors bow during the 1989 through 1992 financial statement audits as follows privation of Key Customer Comptronix lost a key client to SCI afterwardsward the unrestricted offering of stock. Once the telephoner lost their a key customer, Management give up a strong motivation ensure gross sales and operatin g surgical operation to satisfy investor expectations because the loss of a key customer put too much pressure level on vigilance to meet the requirements of external users. Public Offering of Stock After Comptronix do its public offering of stock , they score the pressure which push the management to manipulate operating execution too meet the expectations from the external users.Technological procession Comptronix is a manufacture union which main products atomic number 18 traffic circle get alongs and the circuit come alongs development depend on technological improvement. The technological improvement has a negative impact on operating performance. Pressures from a modern protagonist Company By the first year of the fraud (1989), Comptronix became a new family which send packing employ more than 1,800 employees in less than a decade , and at same time, the troupe expanded its the size of the company in leash different locations. The rapid development of company made the management adjusted their operations instead of monitoring company operations. mind of Accounts The high inherent risk accounts include Accounts receivable/ account 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 losses from 1986. Until the company attracted a venture capitalist, the company was able to generate strong sales and profits. Prior to 1989, Comptronix had generated only both 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 convey up operating accounts to look perfect to attract more investors. 3. An otherwise component of the audit risk model is control risk. Describe the quintette components of internal control. What characteristics of Comptronixs internal control change magnitude control risk for the audits of the 1989-1992 year-end financial statements?Five components of control risk are control environment, risk assessment, control activities, learning and communication, and monitoring. Control environment set the tone of an institution by influencing the control consciousness of batch. Risk assessment is managements process for locateing, analyzing, and responding to the risks. Control activities are policies and procedures that help ensure that managements directives are carried out. Information is necessitate at all levels of an organization to take care 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 executives were able to perpetrate the fraud by bypassing the existing accounting system. They could render the fictitious entries manually and other employees were ex cluded from the manipulations to minimize the likelihood of the fraud universe discovered.Besides, the weak control activity and monitoring is represented by the fact that Mr. Shifflett or Mr. Medlin could approve payments based solely on an invoice. Therefore, the fraud squad 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 entry the shipping department system.4. The bill of fare of directors, and its audit citizens committee, can be an effective somatic 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 depart sufficient information in hallow to answer decisions those are in the maximum profits of shareholders. However, if the inside directors have improper purposes, its easily to be a manipulation dickhead for management.Audit committee is responsible for ensuring that the companys financial statements and reports are accurate and use fair and reason outable estimates. More specifically, it is charged with overseeing the financial account 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 importantly influenced by the effe ctiveness 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 freedom from management, the experience and stature of its members. However, among the seven individuals in Comptronix board of directors, five members are either inside directors or directors had close affiliations with management.In addition, the direct responsibility of the board of directors is to protect the shareholders assets and ensure they receive a fit return on their investment. Board members act as trustees of the organizations assets and must exercise out-of-pocket diligence to oversee that the organization is strong 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 calm of independent directors who are not officers or employees of the organization and who do not have other relationship s that impair independence. However, The audit committee of Comptronix is made up two external directors and one gray director, which would inevitably impair the independence.Whats more, to qualify, the committee must be composed of international 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 inform 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 every quarter financial statements in Form 10-Qs, that have been reviewed by the companys external auditor. Briefly describe the key requirements of Auditing Standards (AU) Section 722, Interim monetary Statements. Why wouldnt all companies (public and private) engage their auditors to perform timely reviews of temporary financial statements?The term inte rim 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 spliff decision of the client 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 return 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 approximately the firms audit assurance and insurance needs.6. Describe whether you think Comptronixs executive team was inherently for sale from the beginning. How is it manageable for otherwise honest nation to become involved in frauds like the one at Comptronix?We fathert 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 challenging 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 do 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 chief operating officer 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, an d 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 disobey the independence and effectiveness 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 considerable 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 antecedent 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 fr aud. 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 burlesque in a Financial Statement Audit, notes that three conditions are generally present when fraud occurs. Research the authoritative standards for auditors and provide a brief outline 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 turn over controlsthat provide an hazard 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 profit on the income statement, to attract more investors and make the stock price 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 quar terly sales frequently.8. Auditing Standards Section 316, Consideration of Fraud in a Financial Statement Audit, notes that there is a speculation that management override of controls could occur in every audit and accordingly, the auditor should include audit procedures in every audit to foretell 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 office to manipulate both sales documents and accounts receivable documents. Thus he can enter bogus sales into the accounting system then make fake accounts receivable to overstate the companys earnings.Moreover, in social club 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 and 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 further 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 transaction s.