A7. (LO 1-4) Fraud Early Career Critical Thinking The following audit program provides an assessment of a public company's control environment at the time that top management was perpetrating a significant financial statement fraud scheme. Despite external audits each year, as required by law, the fraud took place over several years. Fint, identify whether each of the 12 controls in the audit pro- gram exist in the company. Then, based on the observations recorded in the program, explain how you would assess the control environ ment of this company. Are there red flags leading you to be suspicious of fraud occurring in this firm? Explain. COSO 6 7 8 3 4 5 W . Principle Commitment to integrity and ethical values Commitment to integrity and ethical values Commitment to integrity and ethical values Management's competence Proper oversight by board of directors and audit committee Proper oversight by board of directors and audit committee Management's philosophy and operating style Management's philosophy and operating style 9 Organizational structure 10 Assignment of authority and responsibility 11 Assignment of authority and responsibility 12 Human resources policies and procedures Control Objective Employees know what behavior is acceptable and unacceptable under the company's code of conduct and know what to do if they encounter improper behavior Individual compensation awards are consistent with the ethical values of the company and foster an appropriate ethical tone (e.g. bonuses are not given to those who meet objectives but in the process circumvent established policies, procedures, or controls) There is regular identification, measurement, and reporting of losses arising from violations of laws and regulations. Company personnel have the competence and training necessary for their assigned duties. Board committees exist. The board is an independent governing body that provides oversight for management's activities. The audit committee meets privately with the chief accounting officer, internal auditors, and external auditors to discuss the reasonableness of the financial reporting process and system of internal control. There is a monitoring process for turnover of management and supervisory personnel. There is an assessment of the reasons for significant turnover. Management exemplifies attitudes and actions reflecting a sound control environment and commitment to ethical values, including for financial reporting as it relates to appropriate resolution of disputes over application of accounting treatments. Executives understand their responsibility for and authority over business activities. They understand how they relate to the business as a whole. Audit Observations Employees are intimidated by the CEO's harsh behavior and are unwilling to question his authority. Compensation in the form of bonuses for executives and managers is dependent on following the CEO's directives to improve the financial performance of the company. Medicare has filed a lawsuit against the company for falsifying records. Management ignored these violations until details of the lawsuit became public. There was no identification or mention of potential losses in prior management and audit reports. Top management employees are competent to perform their roles due to prior experience and professional qualifications. There is no reason to suspect that management is incompetent. There is little evidence that the board of directors provides oversight over top management, Board members do not question the financial statements provided by management. The CEO handpicked the board and exerts control over them There is no evidence of the board questioning the reasonableness of the financial statements. Consequently, the audit committee did not raise issues about the financial reporting process or the system of internal control. There has been significant turnover in the chief financial officer position, with five different CFOs over the past eight years. There is no evidence of a monitoring process for turnover and no record of the reason for this phenomenon. There is evidence that the CEO has tried to circumvent generally accepted accounting practices by coercing his employees to "fix" the financial statements. It seems, based on an interview with the CEO, that he does not hold himself responsible for the actions of his employees. He said he is not an accountant and that he did not understand "why I am expected to know what the accountants do." Employees are empowered, when appropriate, to correct The control environment is very autocratic. Employees problems or implement improvements. The board of directors and/or audit committee adequately considers their understanding of how management identifies, monitors, and controls business risks. Disciplinary actions send a message of intolerance for violations of expectations regarding behavior. do not feel empowered. They are afraid of the CEO. There is no evidence that the board of directors has an i understanding of management's process for assessing and monitoring risk. There is evidence that top management violated behavioral expectations. For instance, executives often used the company jet and helicopter for personal reasons, without any disciplinary action against them.