Assume that your client possesses the following characteristics associated with the fraud triangle:
Incentives:
• Need to obtain additional debt or equity financing to stay competitive, including financing of major research and development or capital expenditures
• Significant portions of their compensation (e.g., bonuses, stock options, and earn-out arrangements) being contingent upon achieving aggressive targets for stock price, operating results, financial position, or cash flow
Opportunities:
• Significant related-party transactions
• Audit committee meets the criteria for outsiders, but most members have been involved for many years
• There are no significant monitoring controls, especially those that look for trends in reports
• Control deficiencies dealing with the proper pricing and authorization of transactions by sales personnel identified last year have not yet been rectified
Rationalizations:
• Strong interest by management in maintaining or increasing the entity's stock price or earnings trend
• A practice by management of communicating to analysts, creditors, and other third parties that they will achieve somewhat aggressive earnings and revenue forecasts
• Some attempts by management to justify marginal accounting on the basis that problems noted by the external auditor are immaterial
Required
In your groups address the following:
a. Discuss these client characteristics in your group and then use the seven-step Decision Analysis Framework introduced in Chapter 3 to make an assessment of fraud risk on a scale from 1 (very low fraud risk) to 10 (very high fraud risk).
b. Identify the factors from the preceding description and then discuss which combination of factors will influence the fraud risk assessment.
Once your group has made your fraud risk assessment, you will be asked by your instructor to communicate that assessment to the class as a whole, so be prepared to defend your answer.
Recall that the framework includes the following steps:
(1) Structure the problem,
(2) Assess consequences of decision,
(3) Assess risks and uncertainties of the audit problem,
(4) Evaluate information/audit evidence-gathering alternatives,
(5) Conduct sensitivity analyses,
(6) Gather information/audit evidence,
(7) Make decision.