Evaluation of Comptronix Corporation: Identifying Inherent Risk and Control Risk Factors Essay

1. Professional scrutiniseing standards present the inspect insecurity of infection model, which is used to determine the nature, timing, and extent of examine procedures. find out the comp matchlessnts of the model and c anywhere how changes in each component affect the inspectors insufficiency for evidence. The audit riskiness model is used to determine the nature, timing, and extent of crucial audit procedures. The components of audit risk model usu eithery stated as follows DR = AR/(IR x CR)Where DR = detection risk AR = audit risk IR = implicit in(p) risk CR = fake risk spotting hazard auditors procedures will lead them to conclude that a pecuniary pedagogy assertion is not materially misstated when in f playact such misstatement does exist. If auditors want to decrease DR, they had better collect to a greater extent evidence and make legitimate the validity of evidence. Audit Risk auditors may unknowingly fail to fittingly modify their opinion on fiscal st atements that ar materially misstated. If AR should be keep in low level, which means the former(a) risks too should be low.Inherent Risk The risk of material misstatement of a pecuniary statement assertion, assuming there were no link up disciplines. As inherent risk increases, PDR decreases, which in turn increases the auditors need for impregn opener evidence. stop risk The risk that a material misstatement that could occur in an work out will not be prevented or detected on a timely basis by familiar constraint. If the strength of inwrought guard is assessed as decreasing, the auditor should pay more(prenominal) attention to control risks.2. iodin of the components of the audit risk model is inherent risk. Describe typical factors that auditors measure out when assessing inherent risk. With the benefit of hindsight, what inherent risk factors were present during the audits of the 1989 through 1992 Comptronix financial statements? Inherent risk is a measure of the auditors estimate of the susceptibility of an assertion to a material misstatement assuming there atomic number 18 no related innate controls. Some believe that inherent risk would be greater for some assertions and related account based on some conditions as followsComplex calculations rather than simple calculations.Once the keep familiarity lost their a differentiate node, Management absorb a strong motivation manipulate gross revenue and operating(a) performance to satisfy investor expectations because the qualifying of a key customer put too much military press on forethought to join the requirements of external users. habitual Offering of acquit After Comptronix made its public offering of stock , they have the impel which push the anxiety to manipulate operating performance too meet the expectations from the external users.Technological Improvement Comptronix is a manufacture party which chief(prenominal) products argon circuit boards and the circuit boards development depend on technological improvement.The technological improvement has a negative impact on operating performance. Pressures from a new star Company By the first year of the impostor (1989), Comptronix became a new caller which trick employ more than 1,800 employees in less than a decade , and at same time, the company expanded its the size of the company in three different locations. The quick development of company made the management adjusted their operations rather of observe company operations. Estimation of Accounts The high inherent risk accounts let in Accounts due/ payable, inventory, and property, plant, and equipment. just now all the accounts computation is based on estimation which led the numbers are very unreliable and subjective.Cash fly the coop Pressures Comptronix suffered net losses from 1986. Until the company realiseed a venture crownworkist, the company was able to generate strong gross revenue and profits. Prior to 1989, Comptronix ha d generated only two serial years of profit aft(prenominal) several years of net losses. property flow of financial statement cannot cover legion(predicate) years of repeat losses. The management has motives to make up operating accounts to look perfect to attract moreinvestors. 3. Another component of the audit risk model is control risk. Describe the five components of internal control. What characteristics of Comptronixs internal control change magnitude control risk for the audits of the 1989-1992 closing financial statements?Five components of control risk are control surround, risk assessment, control activities, information and communication, and observe. Control surround set the tone of an organization by influencing the control consciousness of people. Risk assessment is managements process for identifying, analyzing, and responding to the risks. Control activities are policies and procedures that suspensor check up on that managements directives are carried out. Information is needed at all levels of an organization to assist management in meeting the organizations objectives.Monitoring of controls is a process to assess the quality of internal control performance over time. The information and communication is seriously indistinct in that he three decision makers were able to perpetrate the fraud by bypassing the existing be system. They could record the fictitious entries manually and other employees were excluded from the manipulations to disparage the wantlihood of the fraud being ascertained.Besides, the weak control activity and monitoring is represented by the fact that Mr. Shifflett or Mr. Medlin could approve payments based entirely on an invoice. Therefore, the fraud team was able to bypass internal controls over cash disbursements.Internal controls were also in satisfactory to detect the manipulation of sales and accounts receivable. Mr. Medlin had the ability to access the shipping department system.4. The board of theat re directors, and its audit chargetee, can be an effective corporate governance mechanism. Discuss the pros and cons of allowing inside directors to shriveled on the board. Describe typical responsibilities of audit committees.What strengths or weaknesses were present related to Comptronixs board of directors and audit committee?As shareholders have moderate access to the sufficient information, they are hard to monitor the daily legal proceeding and management. They would delegate the responsibilities to the board of directors. Then, board of directors require inside directors to exit sufficient information in order to make decisions those are in the uttermost profits of shareholders. However, if the inside directors have improper purposes, its easily to be a manipulation tool for management.Audit committee is responsible for ensuring that the companys financial statements and reports are accurate and use fair and sane estimates. More specifically, it is charged with oversee ing the financial reporting and disclosure process, monitoring quality of history policies and principles, overseeing hiring, performance and independence of the external auditors, oversight of regulatory compliance, monitoring the internal control process, overseeing the performance of the internal audit function, and discussing risk management policies and practices with management.The control environment is significantly influenced by the effectiveness of its board of directors or its audit committee. Factors that require on the effectiveness of the board or audit committee include the extent of its independence from management, the pass and stature of its members. However, among the vii individuals in Comptronix board of directors, five members are either inside directors or directors had close affiliations with management.In addition, the primary responsibility of the board of directors is to protect the shareholders assets and ensure they receive a decent return on their investment. Board members act as trustees of the organizations assets and must exercise due application to oversee that the organization is well managed and that its financial situation remains sound. But the composition of Comptronixs board of directors obviously lacks objectivity.A qualifying audit committee should be quiet of independent directors who are not officers or employees of the organization and who do not have other relationships that violate independence. However, The audit committee of Comptronix is made up two outside directors and one fair-haired(a) director, which would inevitably impair the independence. Whats more, to qualify, the committee must be composed of outside director with at least one qualifying as a financial expert. Nevertheless, for Comptronix Corporation, there is no indication of whether any of these individuals had story or financial reporting backgrounds. Lastly, the audit committee met only double during 1991, it was not efficiently and suf ficiently to monitor and oversee the financial reporting.5. Public companies must file every quarter financial statements in Form 10-Qs, that have been checked by the companys external auditor. Briefly describe the key requirements of Auditing Standards (AU) subdivision 722, Interim Financial avowals. Why wouldnt all companies (public and private) follow up on their auditors to perform timely reviews of interim financial statements?The term interim financial information means financial information or statements covering a period less than a full year or for a 12-month period ending on a date other than the entitys fiscal year end.A review consists principally of performing uninflected procedures and making inquiries of persons responsible for financial and accounting matters, and does not contemplate (a) quiz of accounting records through inspection, observation, or confirmation (b) tests of controls to evaluate their effectiveness (c) the guard net of corroborating evidence in response to inquiries or (d) the performance of trustworthy other procedures ordinarily performed in an audit.The decision to have a review engagement is a joint decision of the client and auditor. So a review would be performed when the benefits to the auditor and to the client exceed the costs to some(prenominal) parties. In general, firms with high complexity are more likely to be reviewed than firms with low complexity. Firms with high growth opportunities a less likely to be reviewed than those with low growth opportunities for they may be associated with higher information and litigation risks. And its also about the firms audit assurance and insurance needs.6. Describe whether you think Comptronixs exe pick outive team was inherently beguiling from the beginning. How is it possible for otherwise honest people to become involved in frauds like the one at Comptronix?We dont think Comptronixs executive team was inherently dishonest from the beginning. In opposite, we thi nk there are two main reasons for the company committed the fraud.The first is its weak internal control.First comes to the companys board of director. The board of directors is responsible for overseeing the actions of management. Factors that bear on the effectiveness of the board include the extent of its independence from management, the experience and stature of its members, the extent to which it raises and pursues difficult questions with management, and its interaction with the internal and external auditors. the audit committee of the board of directors should be composed of independent directors who are not officers or employees of the organization and who do not have other relationships that impair independence. In addition, the audit committee should have one or more members who have financial reporting expertise.However, Comptronixs board of directors consist of the chief executive officer and the COO of the company, And two of the other five directors who had close af filiations with management, one served as the companys outside general legal counsel and the other who served as vice president of manufacturing for a significant customer of Comptronix, and one of the remaining outside directors who was a partner in the venture capital firm that owned 574,978 shares (5.3%) of Comptronixs common stock, the second outside director who was the vice chairman and CEO of the local bank originally loaning money to the company, and the third outside director who was president of an international components set upr based in Taiwan.And there was no indication of whether any of these individuals had accounting or financial reporting backgrounds. 28.6% of the board consisted of inside directors. And even all of the board of directors disobey the independence and effectiveness of the formation of the board of directors. The recreate relationship with the company increased the potential risk for the management to commit fraud.The second reason is the huge pres sure of harsh competition for the companies in the industry. The fraud was motivated by the loss of a key customer in 1989 to the three executives former employer, SCI. Since the first manipulation of the financial statement, they were coerce to manipulate the other years and evidences to hide the manipulation, which created a vicious circle.In conclusion, the weak internal control system provided a good environment for the commission of fraud. The huge pressure of the company brought the motivation of the fraud. Both of them contend important roles for the honest people to become involved in frauds.7. Auditing Standards (AU) Section 316, Consideration of Fraud in a Financial Statement Audit, notes that three conditions are generally present when fraud occurs. look into the authoritative standards for auditors and provide a brief summary of each of the three fraud conditions. Additionally, provide an example from the Comptronix fraud of each of the three fraud conditions.(1) Thre e fraud conditionsFirst, management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. Second, circumstances existfor example, the absence seizure of controls, ineffective controls, or the ability of management to override controlsthat provide an hazard for a fraud to be perpetrated. Third, those involved are able to free committing a fraudulent act. Some individuals possess an attitude, character, or set of good values that allow them to knowingly and intentionally commit a dishonest act.(2) ExamplesThe incentive for top company executive to do fraud is that after the company went public, the company needed an increasing number for profit on the income statement, to attract more investors and make the stock price higher and higher. mavin of the opportunities for fraud perpetrated in Comptronix is that their internal controls were so insufficient. The three executives had so many authorities to get access to various accounts. They can get control of both checks and accounts payable, which enable them to make fake equipment purchasing recording.Because Comptronixs quarterly filings were unaudited, the executives were successful in manipulating quarterly financial statements. After they successfully manipulated 1989 year-end sales and receivables, they thought their performance may not be discovered by external auditors and SEC, so they began recording fictitious quarterly sales frequently.8. Auditing Standards Section 316, Consideration of Fraud in a Financial Statement Audit, notes that there is a possibility that management override of controls could occur in every audit and accordingly, the auditor should include audit procedures in every audit to address that risk.a. What do you think is meant by the term management override?Management override of internal controls is the intervention by managers in handling financial information and making decisions contrary to internal control policy. Managers may think they have the ability to operate outside of the internal controls, but this is not true.b. provide two examples of where management override of controls occurred in the Comptronix fraud.For example, Mr. Medilin, as controller and treasurer, has the authorization to manipulate both sales documents and accounts receivable documents. Thus he can enter bogus sales into the accounting system then make fake accounts receivable to overstate the companys earnings. Moreover, in order to overstate the equipment and accounts payable, the three company executives cut fake checks to the bogus accounts payable vendors associated with the fake purchases of equipment. However, the check preparing and recording of equipment purchases jobs should be distributed to different staff. Handling these two jobs at the same time by same executives provide them opportunity to make overstated recording of equipment purchasing.c. Research AU Section 316 to identify the three involve auditor responses to make headway address the risk of management override of internal controls.Three required auditor responses to further address the risk of management override (1) Examining ledger entries and other adjustments for evidence of possible material misstatement due to fraud. (2) Reviewing accounting estimates for biases that could firmness of purpose in material misstatement due to fraud. (3) Evaluating the business rationale for significant comical transactions.