Jose Is a Senior Auditor in Charge of Testing Controls

question 68

Essay

Jose is a senior auditor in charge of testing controls over financial reporting.
The audit procedures require that Jose "maintain professional skepticism in assessing
controls for fraud risk." In the course of his testing, Jose finds a transaction that
occurred on January 5 at 11:30 P.M. that decreased the bad debts reserve account
enough to increase earnings per share to $.20, which met analysts' predictions. Jose
has a bad feeling about this transaction. For documentation purposes, he must articulate
the red flags for fraud risk for this transaction.
Required:
(a)What are the red flags for fraud risk demonstrated by this transaction?
(b) For each red flag state (a) why it is important, in other words what it suggests to
the auditor and (b) the follow-up procedure that Jose might use.

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Definitions:

Variable Costs

Costs that vary directly with the level of production or output, such as materials and labor.

Fixed Costs

Costs that do not change with the level of output or sales, such as rent or salaries.

Profit-Maximizing

The operational method a firm adopts to calculate the pricing and output that bring in the highest profit.

Average Total Costs

The total cost of production divided by the quantity of output produced, illustrating the cost per unit of output.