Summary of Observations And Identified Fraud Risks

Fraud Considerations

Entity / Prepared
Subsidiary or Division / Approved
Financial Statement Date / Partner

Document below the risks of material misstatement due to fraud. We expect one or more fraud risks will be identified for most engagements.

Identified Fraud Risks
  • Improper revenue recognition*

*Risks associated with improper revenue should be tailored to the specific engagement (e.g. side agreements, channel stuffing, incentive to accelerate revenue recognition, past history of improper sales cut-off).

Document below the key observations from the various sources of information in other parts of this form that support the identified fraud risks listed above.

Observations from Part 1 – Considering the Components of InternalControlat the Entity Level
Observations from Part 2.1 – Engagement TeamDiscussion
Observations from Parts 2.2 and 2.3 – FraudRisk Factors
Observations from Part 2.4 – PlanningAnalytics
Observations from Part 2.5 – Inquiries
Observations from Part 2.6 – Other Information

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Summary of Identified Fraud Risks and Planned Responses

Audit Responses to Identified Fraud Risks HlinkA1

For each of the fraud risks identified, provide a brief description of our planned audit response. Our planned audit response can be (1) a response that has an overall effect on how the audit is conducted (e.g., assigning additional persons with specialized skills or knowledge to the engagement, performing procedures at locations on an unannounced basis) and/or (2) a specific response involving the nature, timing, or extent of our auditing procedures (i.e., tests of the operating effectiveness of programs and controls and/or substantive procedures). Because management may have the ability to override controls that otherwise appear to be operating effectively, it is unlikely that audit risk can be reduced to an appropriately low level by performing only tests of controls.

Risk:
Audit Response:
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Document below our observations about the entity’s programs and controls that address or mitigate the identified risks of material misstatement due to fraud. We are required to evaluate whether such programs and controls are suitably designed and have been placed in operation. In addition, an identified risk of fraud can never be completely mitigated by programs and controls. Accordingly, we always will perform some substantive procedures to respond to the particular fraud risk, in addition to any tests of the programs and controls.

Procedures to Address the Risk of Management Override

1)Review significant nonstandard journal entries through the whole year/period to identify unusual or significant (over 10% percent of TE) items that might not have been identified through other audit procedures. Consider scanning the general ledger, general journal, or other journals to identify significant postings from unusual sources. Inquire of appropriate client personnel and examine supporting documentation to determine that entries or postings identified (other than those covered by other audit procedures) were properly authorized and accounted for.

Note: These procedures should be performed by at least a senior or, depending on the nature and complexity of the financial statement close process, a manager. The involvement of a TSRS professional with appropriate experience (e.g., senior or above) also may be required for clients with highly automated or complex systems.

2) Review significant accounting estimates for evidence of management biases, including a retrospective review of significant estimates recorded in the prior year.

3)Evaluate the business rationale for significant unusual transactions

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

HlinkA3Description and Characteristics of Fraud

Two types of misstatements are relevant to our consideration of fraud: 1) misstatements arising from fraudulent financial reporting; and 2) misstatements arising from misappropriation of assets (for which the effect of the misappropriation causes the financial statements not to be presented, in all material respects, in conformity with generally accepted accounting principles). As we gather information to identify risks of material misstatement due to fraud, we consider both types of misstatements.

Three conditions generally are present when fraud occurs: (1) management or other employees have an incentive or are under pressure that provides a reason to commit fraud; (2) circumstances exist —for example, the absence of controls, ineffective controls or the ability of management to override controls— that provide an opportunity for a fraud to be perpetrated; and (3) those involved are able to rationalize a fraudulent act as being consistent with their personal code of ethics. Some individuals possess an attitude, character, or set of ethical values that allow them to knowingly and intentionally commit a dishonest act. However, even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them. The greater the incentive or pressure, the more likely an individual will be able to rationalize the acceptability of committing fraud.

Although the risk of material misstatement due to fraud may be greatest when all three fraud conditions are observed or evident, we cannot assume that the inability to observe one or two of these conditions means there is no risk of material misstatement due to fraud.

Certain assertions, accounts, and classes of transactions that have high inherent risk because they involve a high degree of management judgment and subjectivity also may present risks of material misstatement due to fraud because they are susceptible to manipulation by management. For example, liabilities resulting from a restructuring may be deemed to have higher inherent risk because of the high degree of subjectivity and management judgment involved in their estimation. Similarly, revenues for software companies may be deemed to have higher inherent risk because of the subjectivity and complexities often involved in recognizing and measuring software revenue transactions.

We expect that one or more risks of material misstatement due to fraud will be identified for most engagements. In particular, there is a presumption that we ordinarily will identify one or more fraud risks relating to revenue recognition.

Although the fraud risk factors below cover a broad range of situations, they are only examples and, accordingly, we may wish to consider additional or different risk factors. Also, the examples of fraud risk factors are not presented in an order that might reflect their relative importance or frequency of occurrence. In addition, risk factors known to the engagement team but not included in Parts 2.2 and 2.3 should be added to the applicable sections.

The relative importance of the risk factors varies among engagements from critical to insignificant. Accordingly, we exercise considerable professional judgment when considering the risk factors individually and in combination.

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

1 Engagement Team Discussion(s)

Hlink21In planning the audit, members of the audit team discuss the potential for material misstatement due to fraud. The objectives of this discussion are (1) to increase the overall awareness of and sensitivity to fraud by all members of the team, (2) to have an interactive exchange of ideas and sharing of information about how and where the entity’s financial statements might be susceptible to material misstatement due to fraud, and (3) for the executive in charge of the audit to emphasize the importance of maintaining the proper state of mind and level of professional skepticism throughout the audit.

Refer to Procedure 4.3 of the Global Audit Methodology for additional guidance on the engagement team discussion(s) regarding participants and types of information that may be helpful to the discussion(s). Although our consideration of fraud risk is an ongoing process during the audit, at least one such engagement team discussion takes place as part of the team planning event.

Document below or in a separate memorandum the engagement team discussion(s) about the susceptibility of the client’s financial statements to material misstatement due to fraud. The documentation includes how and when the discussion(s) occurred, and the team members who participated. Observations from the engagement team discussion that should be considered in identifying and assessing the risks of fraud are documented in the Summary of Observations and Identified Fraud Risks.

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Part 2 — Identifying Potential Risks Of Material Misstatement Due To Fraud

Fraud Risk Factors Associated With Fraudulent Financial Reporting and Misappropriation of Assets

Identifying one or more fraud risk factors does not necessarily mean that internal control at the entity level is ineffective. However, the presence of numerous fraud risk factors should heighten our awareness, and we would give them due consideration in making our assessment of internal control at the entity level. In this regard, we pay particular attention to risk factors relating to attitudes of management or the board of directors, or opportunities resulting from inappropriate attention to, or a disregard for, internal control.

Hlink222 Risk Factors Relating to Fraudulent Financial Reporting
Incentives/Pressures
a. / Financial stability or profitability is threatened by economic, industry, or entity operating conditions, such as (or as indicated by):
-High degree of competition or market saturation, accompanied by declining margins.
-High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates.
-Significant declines in customer demand and increasing business failures in either the industry or overall economy.
-Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover imminent.
-Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth.
-Rapid growth or unusual profitability, especially compared to that of other companies in the same industry.
-New accounting, statutory, or regulatory requirements.
b. / Excessive pressure exists for management to meet the requirements or expectations of third parties due to:
-Profitability or trend level expectations of investment analysts, institutional investors, significant creditors, or other external parties (particularly expectations that are unduly aggressive or unrealistic) including expectations created by management in, for example, overly optimistic press releases or annual report messages.
-Need to obtain additional debt or equity financing to stay competitive—including financing of major research and development or capital expenditures.
-Marginal ability to meet debt repayment or other debt covenant requirements.
-Perceived adverse effects of reporting poor financial results on significant pending transactions, such as business combinations or contract awards.

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

2 Risk Factors Relating to Fraudulent Financial Reporting (Continued)

Incentives/Pressures (Continued)
c. / Management or the board of directors’ personal net worth is threatened by the entity’s financial performance due to:
-Significant personal finanical interests in the entity.
-Significant portions of their compensation (e.g., bonuses, stock options) being contingent upon achieving aggressive targets for stock price, operating results, financial position, or cash flow.
-Personal guarantees of debts of the entity.
d. / Excessive pressure on management or operating personnel (including those at subsidiaries or remote locations with separate systems or records) to meet financial targets set up by the board of directors or management, including sales or profitability incentive goals.
HLinkI Indicate any of the above or other risk factors to be considered relating to incentives/pressures associated with misstatements arising from fraudulent financial reporting:

Opportunities

a. / The nature of the industry or the entity’s operations provides opportunities to engage in fraudulent financial reporting due to:
-Significant related party transactions not in the ordinary course of business or with related entities not audited or audited by another firm.
-A strong financial presence or ability to dominate a certain industry sector that allows the entity to dictate terms or conditions to suppliers or customers that may result in inappropriate or non-arm’s length transactions.
-Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate.
-Significant, unusual, or highly complex transactions, especially those close to year end that pose difficult “substance over form” questions.
-Significant use of derivatives and complex hedging activities.
-Significant operations located or conducted across international borders in jurisdictions where differing business environments and cultures exist.
-Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for which there appears to be no clear business justification.
-The degree of decentralization and oversight of remote locations.

Opportunities (Continued)

b. / There is ineffective monitoring of management due to:
-Domination of management by a single person or small group (in a non-owner managed business) without compensating controls.
-Ineffective board of directors or audit committee oversight over the financial reporting process and internal control.
-Lack of management personnel with sufficient knowledge and competence to recognize when other members of management may attempt to commit fraud.
c. / There is a complex or unstable organizational structure as evidenced by:
-Difficulty in determining the organization or individuals that have a controlling interest in the entity.
-Overly complex organizational structure involving unusual legal entities or managerial lines of authority.
-High turnover of senior management, counsel, or board members.
d. / Internal control components are deficient due to:
-Inadequate monitoring of controls, including automated controls and controls over interim financial reporting (where external reporting is required).
-High turnover rates or employment of ineffective accounting, internal audit, or information technology staff.
-Ineffective accounting and information systems
-Reportable conditions

Indicate any of the above or other risk factors to be considered relating to opportunities associated with misstatements arising from fraudulent financial reporting:

Attitudes

Risk factors reflective of attitudes by board members, management, or employees that allow them to engage in and/or justify fraudulent financial reporting may not be susceptible to observation. Nevertheless, if we become aware of the existence of such information, we should consider it in identifying the risks of material misstatement arising from fraudulent financial reporting.

a. / Ineffective communication and support of the entity’s values or ethical standards by management or the communication of inappropriate values or ethical standards.
b. / Nonfinancial management’s excessive participation in, or preoccupation with, the selection of accounting principles or the determination of significant estimates.
c. / Known history of violations of securities laws or other laws and regulations, or claims against the entity, its senior management, or board members alleging fraud or violations of laws and regulations.
d. / Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend.
e. / A practice by management of committing to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts.
f. / Management failing to correct known reportable conditions on a timely basis.
g. / An interest by management in employing inappropriate means to minimize reported earnings for tax-motivated reasons.
h. / Recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality.
i. / The relationship between management and us or management and the predecessor auditor is strained as exhibited by:
-Frequent disputes with us or the predecessor auditor on accounting, auditing, or reporting matters.
-Unreasonable demands such as excessive fee pressure, or unreasonable time constraints regarding the completion of the audit or the issuance of the auditor’s report.
-Formal or informal restrictions that inappropriately limit access to people or information or the ability to communicate effectively with the board of directors or audit committee.
-Domineering management behavior, especially involving attempts to influence the scope of our work or the selection or continuance of audit personnel assigned to the engagement.
HlinkDIndicate any of the above or other risk factors to be considered relating to attitudes associated with misstatements arising from fraudulent financial reporting:

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

3 Risk Factors Relating to Misappropriation of Assets

HLinkKHlink23Risk factors that relate to misstatements arising from misappropriation of assets are also classified along the three conditions generally present when fraud exists: 1) incentives/pressures, 2) opportunities, and 3) attitudes. Many of these risk factors relate to a disregard for, or inappropriate attention to, safeguarding of assets or controls over assets that are susceptible to misappropriation. Some of the risk factors related to misstatements arising from fraudulent financial reporting also may be present when misstatements arising from misappropriation of assets occur. For example, ineffective monitoring of management and weaknesses in internal control may be present when a misstatement due to either fraudulent financial reporting or misappropriation of assets exists.

Incentives/Pressures
a. / Personal financial obligations may create pressure on management or employees with access to cash or other assets susceptible to theft to misappropriate those assets.
b. / Strained, difficult or adverse relationships between the entity and employees with access to cash or other assets susceptible to theft may motivate those employees to misappropriate those assets. Such relationships may be created by:
-Known or anticipated future employee layoffs.
-Recent or anticipated changes to employee compensation or benefit plans.
-Promotions, compensation, or other rewards inconsistent with expectations.
Indicate any of the above or other risk factors to be considered relating to incentives/pressures associated with misstatements arising from misappropriation of assets:

AF-04 (2004)

Drs Joseph Susilo

Registered Public Accountants

Identifying Potential Risks Of Material Misstatement Due To Fraud

3 Risk Factors Relating to Misappropriation of Assets (Continued)

Opportunities

a. / Certain characteristics or circumstances may increase the susceptibility of assets to misappropriation. For example, opportunities to misappropriate assets increase when there are:
-Large amounts of cash on hand or processed.
-Inventory items that are small in size, of high value, or in high demand.
-Easily convertible assets, such as bearer bonds, diamonds, or computer chips.
-Fixed assets that are small in size, marketable, or lacking observable identification of ownership.
b. / Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. For example, misappropriation of assets may occur because there is a(n):
-Inadequate segregation of duties or independent checks.
-Inadequate management oversight of employees responsible for assets -- for example, inadequate supervision or monitoring of remote locations.
-Inadequate job applicant screening of employees with access to assets.
-Inadequate recordkeeping with respect to assets.
-Inadequate system of authorization and approval of transactions (for example, in purchasing).
-Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
-Lack of complete and timely reconciliations of accounts.
-Lack of timely and appropriate documentation of transactions, for example, credits for merchandise returns.
-Lack of mandatory vacations for employees performing key control functions.
-Inadequate management understanding of information technology, which enables information technology employees to perpetrate a misappropriation.
-Inadequate access controls over automated records, including controls over and review of computer systems event logs.

NlinkEIndicate any of the above or other risk factors to be considered relating to opportunities assiciated with misstatements arising from misappropriation of assets: