ABC Company manufactures and sells software packages to small businesses. The company has enjoyed great success since it began business in 1998. Last year the firm doubled its revenues, and its management is now looking closely to going public by making an Initial Public Offering (IPO) next September. Senior management has been putting a lot of effort into further increasing sales by offering the company's sales representatives a generous commission as an incentive to increase their selling efforts.

The CEO and the CFO of the company have been in business together for 20 years. They are high school buddies. They interact socially with one another and their wives are also very close.

In completing a background check on the company, you find that it has positive relationship with private investors, who are excited about the IPO next September. One of the investors did inform you that the company changed its auditors last year because of a dispute the CEO had with the audit partner regarding some "revenue recognition rule.

The company has a board of directors and audit committee that meets twice a year to discuss how the business is doing. The board has decided to meet four times over the next year since it may be necessary to discuss issues regarding the upcoming IPO. The board seems to speak highly of management and compensates them generously with stock options for their "good work."

Questions:

1. What areas of business are prone to fraud?
2. Identify 10 red flags that indicate the financial statement fraud may be occurring.
3. Assume that you have been appointed as a forensic accountant to investigate if fraud is taking place in the above organization. Prepare your plan on the investigation procedures you are going to use.
4. Consider the four aspects of the fraud diamond. You were hired by the board of directors to tell them what they could do to prevent fraud. Write a report on the general activities you would tell them to engage in to prevent fraud in their organization. List 4 activities for each of the four dimensions of the fraud diamond.