This memo is to determine potential fraud risks that may exist within our client, Apollo shoes. There are reasons to believe that potential fraud risks do exist, however these risks are only hypothetical, but will be tested to assure users that Apollo’s financial statements are fairly stated. First, the client’s prohibition of contacting the predecessor auditor is considered a red-flag.
The importance of the predecessor’s working papers and comparative work would make completing this audit much more efficient and effective. The prohibition is stated to be caused by litigation between the client and the auditor, due to withdrawal from engagement with little notice. Next, the potential risk of material misstatements arising from fraudulent financial reporting to depict company’s unusual growth in trying economic times, are supported by the following fraud risk factors from SAS 99.
The factors that apply are: (1) high degree of competition, accompanied by declining margins, (2) High vulnerability to rapid changes, such as changes in technology, or product obsolescence, (3) Significant declines in customer demand and increasing business failures in the industry or overall economy, (4) Rapid growth and unusual profitability, (5) overly optimistic press release issued to shareholders, and (6) Need to obtain additional debt to stay competitive. The pressure to remain on top of the industry, from the CEO and expected forecasts, may result in fraudulent activities.
Also claims against the entity for patent infringement, and strained relationship between management and the predecessor auditor, are fraud factors which reflect Apollo’s attitude. The significance of this risk is very high, but the likelihood of this risk is low, due to the complexity needed to perform such a deception of department cooperation. If fraud does exist, it would have to be committed by multiple departments. For example, the Finance departments, treasury and controller offices, may manipulate receipts, accounts receivable and cash management.
I suggest a more thorough inspection of invoices, receipts with connecting accounts that will need more extensive analysis. Finally, the potential risk of material misstatements arising from misappropriation of assets, are supported by the following fraud risk factors from SAS 99. The factors that apply are: (1) recent or anticipated changes to employee compensation or benefit plans, (2) Promotions, compensation, or other rewards inconsistent with expectations, and (3) there are large amounts of cash on hand, due to sales and 44 million draw from line of credit.
The significance of this risk is high, due to a deliberate recording in an inappropriate account, and the likelihood is medium/high, due to the unusual actions the company has taken in their board meetings that are inconsistent and unorthodox. For example, loaning a personal secretary a million dollars for legal expenses, but recording it in “other expenses” instead of “employee advances. ” Also, board bonuses were awarded, while certain highly expected products failed. Also employee benefits are expected to fall in upcoming years.
I suggest a fairly thorough investigation of the use of the 44 million withdrawal from credit, employee pensions, and asset accounts. The loan of the personal secretary being recorded in an account to change the view of shareholders, is very interesting. It creates more probability of fraudulent activity, even though the end result is the same. These factors are indicators of fraud, but are not evidence in itself. Further investigation is needed to conclude whether fraudulent activity has taken place.