Question

As Koss Corporation’s financial statement auditor, what responsibilities did Grant Thornton have to detect the embezzlement and accounting fraud? List and briefly describe at least three red flags that could have alerted the auditor to the fraud. What audit procedures might the auditor has used to address those red flags in order to discover the accounting fraud and the embezzlement?

Answer 1

As an auditor there is no responsibility towards detecting fraud. The purpose of audit is to determine whether the accounting standards are properly followed in all material aspects of the financial position and performance of the business. Keeping this in mind, the responsibility which falls onto the auditor is to reduce the risk of fraud in the AFS to an acceptably low level, meaning the auditor needs to consider the risk of material misstatement in the AFS due to fraud when planning and performing the audit.

Three red flags that could have alerted the auditor to the fraud are:

1) Failing to report all taxable income to keep the taxes at low level but being an auitor it comes easily to the concern of the auditor and he gets an alert about the embezzlement and the fraud.

2) Taking higher than average deductions on your return that is disproportionately large compared with your income. But if you have the proper documentation for the deduction, don't be afraid to claim it.

3) We know that charitable contributions are a great write-off and help you fell all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

Audit procedures to address those red flags in order to discover the accounting fraud and the embezzlement.

While audits are not designed to root out every instance of fraud, auditors have a responsibility to detect material misstatements in the company's financial statements caused by either fraud or error.

1) Journal entry testing

2) Evaluating the significant unusual transactions

3) Review of accounting estimates.