Jon Hampton, president and CEO of Plastics, Inc., is living a life-style beyond his means. He has several short positions to cover with his stock brokers. His creditors are becoming especially aggressive in collecting his debts. Unable to cut back his spending, he borrowed the needed funds from the corporation. In order to make the transactions as complex as possible for any auditor, he used a wholly-owned subsidiary and several banks as tools to move the funds. The usual procedure was to have Plastics issue a note to his subsidiary, Extrusions, Inc. Extrusions discounts the note at one of the banks and transfers the money to Plastics. Plastics then loans the funds to Extrusions, which loan them to Jon Hampton. Although Hampton pledges his stock to Plastics as collateral, the stock’s true value rests upon Hampton’s ability to repay the loans. In this case the loans receivable make up 40% of Plastics total assets. Hampton becomes insolvent due to his bad investing decisions in the stock market.

Required:
What audit procedures would have alerted the auditor to the risk in this situation and the identification of the fraud?