Aaron Mc Lane is a young entrepreneur of a retail business where managers in all of the different stores report directly to him. He does not communicate regularly with other store managers on inventory issues or customer service representative availabilities. Aaron has found much success in the past because of the customer service he has been able to provide. In recent years, the competition has become more successful in duplicating his activities or in providing low-maintenance products. Aaron's company has provided financial statements on a yearly basis, so investors can follow the company's success. With the growing success of competitors, Aaron has found it more difficult to be successful. During the past year, Aaron's company recorded significant revenues from sales that require warranty service over the next few years. However, the company's reported warranty expenses stayed the same. In addition, the reported inventory levels remained approximately the same as in previous years. No additional financing or loans were recorded on the financial statements, even though assets continued to grow. Revenue was the only financial statement amount that changed dramatically.

Required:

a) Cite possible fraud symptoms that auditors should be aware of.

b) As an auditor, how could you justify that those red flags are not real fraud symptoms?

2. A manufacturing company's financial analyst is working on the analysis of financial statements for the last three years. However, the financial analyst cannot decide on what approach and which financial ratios would provide possible fraud indicators. You, being an auditor and fraud examiner was approached him and asked for expert advice.

Required:

a) What type of analysis would you recommend to the financial analyst? Explain.

b) Assuming the following are the resulting ratios/conditions as computed and noted by the financial analyst, would you consider it as a fraud symptom? Why or why not?

a.1 Current ratio of 3.5:1.0 and the acid-test ratio of 2:1; both increased from that of previous years

a.2 Finished goods inventory significantly increased as compared with previous years' stocks

a.3 Percentage of uncollectible accounts to total credit sales showed minimal increase although sales registered a material increase

a.4 Cost of rework on items sold, sales discounts and return reduced significantly although with an increase in sales volumes

Note: Other assumptions considered shall be specifically stated.