Lets examine some other accounts with specific risks

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Let's examine some other accounts with specific risks of fraudulent financial reporting or misappropriation. Fixed Assets Fixed assets, a large balance sheet account for many companies, are often based on subjectively determined valuations. As a result, fixed assets may be a target for manipulation, especially for companies without material receivables or inventories. For example, companies may capitalize repairs or other operating expenses as fixed assets. Such frauds are relatively easy to detect if the auditor examines evidence supporting fixed asset additions. Nevertheless, prior cases of fraudulent financial reporting, such as WorldCom, have involved improper capitalization of assets. Because of their value and salability, fixed assets are also targets for theft. This is especially true for fixed assets that are readily portable, such as laptop computers. To reduce the potential for theft, fixed assets should be physically protected whenever possible, engraved, or otherwise permanently labeled, and should be periodically inventoried. Payroll Expenses Payroll is rarely a significant risk area for fraudulent financial reporting. However, companies may overstate inventories and net income by recording excess labor costs in inventory. Company employees are sometimes used to construct fixed assets. Excess labor cost may also be capitalized as fixed assets in these circumstances. Material fringe benefits, such as retirement benefits, are also subject to manipulation. Payroll fraud involving misappropriation of assets is fairly common, but the amounts involved are often immaterial. The two most common areas of fraud are the creation of fictitious employees and overstatement of individual payroll hours. The existence of fictitious employees can usually be prevented by separation of the human resource and payroll functions. Overstatement of hours is typically prevented by use of time clocks or approval of payroll hours. 574 Part2 ITHE PROCESS OF AUDITING
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RESPONSIBILITIES WHEN FRAUD IS SUSPECTED Frauds are often detected through the receipt of an anonymous tip, by management review, internal audit, or by accident. Figure 11-6 highlights the effectiveness of having a whistleblower hotline, with 47o/o of frauds being detected through a tip when a hotline is available versus 34olo without. External auditors detect a relatively small percentage of frauds, but are more likely to detect when the fraud materially impacts the financial statements. Throughout an audit, the auditor continually evaluates whether evidence gathered and other observations made indicate material misstatement due to fraud. All mis- statements the auditor finds during the audit should be evaluated for any indication of fraud. When fraud is suspected, the auditor gathers additional information to determine whether fraud actually exists.
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