The following is a list of defalcations that have occurred within various organizations. You may assume that the amounts involved are material.

Required

For each defalcation, briefly indicate:

a. How the auditor would have identified the risk that led to the defalcation; that is, would the auditor have identified the risk primarily through (1) analysis of financial results, (2) review of industry trends, or (3) review of operational procedures?

b. How the defalcation would likely have been detected. Assuming the amounts are material, should most auditors have detected the defalcation? Explain.

c. What types of control procedures would have been effective in preventing or detecting the defalcation?

Defalcations

1. The treasurer of a small city also managed the city's pension fund.

Over a period of a few years, the treasurer diverted a substantial amount of the fund's earnings to his personal use. Most of the funds were invested in money market funds and certificates of deposit.To cover the diversion, the treasurer systematically underrecorded income earned on the funds.

2. The purchasing agent of a company set up a fictitious vendor and periodically prepared purchase orders to the fictitious vendor. The agent then created bogus receiving reports and sent the receiving reports, vendor invoices, and purchase orders to accounts payable for processing. The fraud amounted to $125,000 a year for a company with approximately $12,000,000 in annual sales.

3. The social services workers of a state agency set up fictitious files for welfare recipients and paid them monthly support. Because the recipients were fictitious, the social services workers collected the checks and deposited them into a bank account and then transferred the amount to the accounts of the fraud perpetrators. All of the records are kept on computerized files.

4. A purchasing agent systematically paid higher-than-market prices for goods received from an important vendor. In turn, the purchasing agent received various perks from the vendor and kickbacks that amounted to more than half of the purchasing agent's regular annual salary.

5. The supervisor of a small manufacturing company and the payroll clerk colluded to add an extra person to the payroll. Time cards were approved by the supervisor, who split the non-employee paychecks with the payroll clerk.

6. The branch manager of a bank manipulated the dormant accounts (of inactive depositors) and transferred amounts from those accounts to a fictitious account, from which he eventually withdrew the cash.

All of the accounts were computerized. Monthly statements were sent to the customers, but all bank personnel were instructed to refer questions about account balances directly to the manager so he could show personal interest in the customers. He would then correct the accounts of any customers who complained.

7. The accounts receivable bookkeeper opens the mail and makes the cash deposit. Over a period of time, she has diverted significant funds to herself, covering up the diversion either by misstating the accounts receivable totals by improperly footing of the accounts, recording fictitious discounts or returns for the amount of money diverted, or writing off as uncollectible the accounts of customers whose payments have been diverted