PRACTICAL ERROR OR FRAUD ANALYSIS FOR FINANCIAL STATEMENTS
Learning Objectives:
I. Comparative Figures from Prior Periods
II. Unusual change in amount
III. New Account Types or Transactions
IV. Relevant Ratios Analysis
V. Analytical Procedures
………………………………………………..
In practice, draft financial statements are submitted by subordinates to their managers, these draft financial statements may be checked the following steps to identify errors or sometime fraud:
I. Comparative Figures From Previous Periods
The comparative financial statements are the way to analyze and compare particular financial statements with prior periods, for example, if company prepares monthly income statement and balance sheet for May 2017, so financial managers may want to compare these financial statements prepared on April 2017 or March 2017 respectively.
These processes will reveal the following concepts:
- Identify trends in the financial figures in financial statements
- Evaluate performance of business
- Easy to identify omitting transactions, e.g. salary expenses are not recorded for May 2017 yet.
- Easy to identify wrong classification, e.g. marketing expenses may be recorded as administration expense.
- Significant changes of amount may be identified, etc.
In practice, we need to know nature of the following transactions:
- Fixed transactions, e.g. salary expenses, pure discount loan, interest-only loan etc.
- Variable transactions
- Semi transactions
- Correlation transactions.
II. Unusual Change in Amount
In practice, financial statement preparers will examine unusual or abnormal change of financial transactions such as asset, liability, equity, revenue and expenses.
For example, transactions increase or decrease beyond 100%.
III. New Account Types or Transactions
New account types or transactions of asset, liability, revenue and expenses should be checked and quested for any explanation.
For example, monthly statement of financial position for April 2017 has only current liabilities, but monthly report for May 2017 includes loan from bank, so we should know interest rate, amount of loan, payment and loan conditions.
IV. Relevant Ratios Analysis
In practice, we need to know correlation transactions. Especially sale and cost of sale are close relationship, so comparative ratios (cost of sale/sale) may be important.
V. Analytical Procedures
Analytical procedures can be defined as the evaluation of financial information by studying the relationships between both financial data and non-financial data.
They also include comparison of financial information with prior periods, budgets and forecasts and similar industries consideration of predictable relationships such as the relationship of purchases to sales, and payroll costs to the number of employees.
Let’s practice with the following example:
Top Trading Group Co.,Ltd is merchandising company, and company has two major products. The following comparative income statements are here.
Currently financial statements are unreliable, so old financial manager resigned for his position. You are new financial manager for Top Trading Group Co.,Ltd, and your accountants prepare financial statements to review, but you suspect that financial statements may have errors or frauds during review.
|
Top Trading Group Co.,Ltd |
||
|
Comparative Income Statement |
||
| For 2015 | ||
| November | December | |
| Sale: | ||
| Sale from Product 1 | 200,000 | 220,000 |
| Sale from Product 2 | 100,000 | 110,000 |
| Sale from Other Products | 160,000 | 176,000 |
| Total Sale | 460,000 | 506,000 |
| Cost of Goods Sold: | ||
| Product 1-COGS | 140,000 | 151,800 |
| Product 2-COGS | 80,000 | 99,000 |
| Other Products-COGS | 144,000 | 123,200 |
| Total COGS | 364,000 | 374,000 |
| Gross Profit | 96,000 | 132,000 |
| Other Income – Rental Income | 2,000 | 3,000 |
| Total Expense: | ||
| Advertising | 4,000 | 4,400 |
| Salary | 10,000 | 9,000 |
| Office supply | 400 | 600 |
| Electricity | 500 | 2,000 |
| Water supply | 300 | 350 |
| Rental | 14,000 | 18,000 |
| Telephone and Internet | 800 | 880 |
| Depreciation | 1,200 | 1,400 |
| Interest expense………………………… | 1,400 | 1,600 |
| Other expense | 740 | 814 |
| Total Expense | 33,340 | 39,044 |
| Net Income/(loss) | 64,660 | 95,956 |
During period, company bought fixed assets more.
Required:
According to your professional judgment, identify possible frauds or errors for comparative income statements if any with reasonable explanation for any suspicion.