Question

Fellowes and Associates Chartered Professional Accountants is a successful mid-tier accounting firm with a large range of clients across Canada. During 2020, Fellowes and Associates gained a new client, Health Care Holdings Group (HCHG), which owns 100 percent of the following entities:
• Shady Oaks Centre, a private treatment centre
• Gardens Nursing Home Ltd., a private nursing home
• Total Laser Care Limited, a private clinic that specializes in laser treatment of skin defects.

Year end for all HCHG entities is June 30.

The audit partner for the audit of HCHG, Tania Fellowes, has discovered that two months before the end of the financial year, one of the senior nursing officers at Gardens Nursing Home was dismissed. Her employment was terminated after it was discovered that she had worked in collusion with a number of patients to reduce their fees. The nurse would then take secret payments from the patients.

The nursing officer had access to the patient database. While she was only supposed to update room-location changes for patients, she was able to reduce the patients’ period of stay and the value of other services provided. The fraud was detected by a fellow employee who overheard the nurse discussing the “scam” with a patient. The employee reported the matter to Gardens Nursing Home’s general manager.

A) Which accounts on the balance sheet and income statement are potentially affected by the fraud?

Revenue is overstated

Revenue is understated

Accounts receivable may be understated

Accounts receivable may be overstated

Cost of goods sold is understated

Room expenses may be understated

Answer 1

In this question, mentions that the nurse was able to reduce the patient's period of stay. This clearly states that she reduces the period of stay , which means the actual room expenses was reduced . So simply she understated the room expense.

Effect of understated expenses in income statement :

All type of expenses whether it is direct or indirect, it only shows on income statement ie, Trading & Profit & Loss alc because its nature is nominal. If the nurse reduced the period of stay of patient, it directly reduced the room rent. If some expense is understated(shows below the actual amout) , it increases the net profit of the firm.

For eg: If Gross profit is 200000 and actual room expense is 10500,

Then actual NET PROFIT is 2,00,000-10,500 = 189500

But here, nurse reduced the room expense as 8000

Now the Net Profit = 2,00,000-8000 =1,92,000

So, understated room expense will affect the income statement.

Secondly, the nurse reduce the value of other services, which means that she reduced the value of services of doctors or she reduced the actual rate of number of medicines taken by patients. This mentions that she reduced the cost of goods sold. Cost of goods sold means that the actual expenses incurred for the sale of product/services. If she reduced the payment of service, that means she reduced the actual cost of firm.

Effect of understated cost of goods:

It will show increase in gross profit of the firm

For eg; If actual sales is 10,00,000 and the cost incurred for sales is 2,00,000 then,

Actal gross profit = 10,00,000 - 2,00,000 = 8,00,000

But here, she reduced the cost of services , suppose she reduced the cost to 1,00,000

then the GROSS PROFIT will be 10,00,000 - 1,00,000 = 9,00,000

In both situation, the balance sheet shows a higher profit than actual profit. If position statement shows high profit , then shareholders as well as investors will expect high return from that profit. If the profit is high, the Government also charge tax according to their stated profit.

So,this fraud will affect by firm.