in practice | How to spot a landmine How to spot a landmine itis an oft chanted mantra that ultimate responsibility for the Prevention or detection of fraud rests with both management and those charged with governance of an entity. Nevertheless, the pressure of this responsibilty is quite often fet by the auditor since ‘the very persons charged with this responsiblity are usually the ‘ones auilty of the most spectacular acts of fraud. This i turn has the resultant effect of an upward shift of this responsibility o the auditor, such responsibility being very generously imposed on the auditor by the general public. Before all you auditors out there start sighing with self pity, let me clarity that thie article ie nat really one about fraud or the audit expectation gap for that matter. The focus of this article is actualy {uite specific with the spotlight ined on journal entries and the marvelously shoddy way in which these are sometimes aucited. usually at year-end that management starts getting desperate ‘and you know the old adage ‘desperate times call for desperate ‘measures’. Therefore, the testing of journal enties and other adjustments are a mandatory requirement of the standard. Journals {and othor adjustments made throughout the year however need ‘only be considered for testing in tarms of the Standard. A word ‘of caution though ~ any fraud worth mentioning is typically elaborately planned and concealed thus making it extremely likely that suspicious journals may very well have been posted before the ‘yearend. There is also the possiblity that journal entries posted at year-end may be backdated in order to escape the auditor's attention. My point, and I do have one, is not to be cavalier about Journals and adjustment made during the period. Be sure to document this consideration of the need to test journal entries and other adjustments throughout the period and ensure that it incorporates at least the following elements: THESE ARE SOMETIMES AUDITED THE FOCUS OF THIS ARTICLE IS ACTUALLY QUITE SPECIFIC WITH THE SPOTLIGHT TURNED ON JOURNAL ENTRIES AND THE MARVELOUSLY SHODDY WAY IN WHICH The ISA's have come some way in helping auditors to decide \where to focus their attention when auditing journal entries. Before | move on to quoting the requirements of the relevant standard, brief background to the stated requirement is perhaps in order ISA 240 The Auditor's Responsislities Relating to Fraud in an Audit of Financial Statements, postulates that management, due 10 its position in an entity, possesses the abilty to override internal controls in order to manipulate accounting records as @ means to fraudulently misstate the financial statements. Further, the risk ‘that management will overide internal controls is present in every ‘entity, albert to varying degrees. As such paragraph 32 of ISA 240 declares that: “irrespective of the auditor's assessment of the ‘risks of management override of controls, the auditor shall design and perform audit procedures to: 2, Test the appropriateness of journal entries recorded in ‘the general ledger and other adjustments made in the reparation of the financial statements. In designing and Performing eudit procedures for such tests, the autor shal: ‘Make inquiries of individuals involved in the financial reporting process about inappropriate or unusual activity, relating to the processing of journal entries and other adjustments; ii, Select journal entries and other adjustments made at the ‘end of a reporting period: and lit. Consider the need to test journal entries and other adjustments throughout the period” ‘The standard itself places particular emphasis on year-end journals. 1. The fraud risk assessment for the entity 2 Controls over journal entries and other adjustments 3. The financial reporting process and the nature of aucit evidence that can be obtained 4. Characteristics of fraudulent journal entiias or other adjustments 5. Nature and complexity af accounts 6. Non-routine journal entrias or adjustments And in ease you missed the requirement in ISA 240, it has been thrown in again for good measure [although with a slightly different ‘wist) in paragraph 20 of ISA 330, The Auditor's Responses to Assessed Risks which states that material journal entries and other adjustments made during the course of preparing the financial Statements must be examined Right then, now that we have the demands of the Standards out of the way, some real life examples of where journal entries have been employed to commit fraud include Worldeom, a thriving Telecommunications company riding the wave of success in corporate America when suddenly it all came ereshing down as the industry encountered @ downturn in 1999-2000, Werldcom's accumulation of debt and expenses and is falling share price, amongst other factors, spurred an accounting fraud which made extensive use of fraudulent journel entries and other adjustments 10 re-classify certain operating expenses to capital accounts in an affort ta misrepresent earnings, not to mention the numerous Improper adjustments made to revenue and reserves, Cioser to home of course, we have the Schabir Shaik bedtime story Gane ce: nlaSince | mentioned earlier that t 10 stop at the two examples above and n is not about fraud, | have on to where | think | can help you to help yoursel. 1 By now, you already know that you have lifyou have forgotten, go back tothe to ‘again and this time, stay awake!) When selecting journal entries to tes place more emphasis on non-outine journal typically not subjact to the entity's internal nature andor the frequency of their proc audit journal entries article and start itis recommended to tries as these are ols due theie Do not ignore journals and adjustments processed before yearend, especially reversing journal entries processed at the Beginning of the year Don't contine year-end journal testing to the last month of the vat ~ it will naver be hidden in the most obvious place Look out fr the following fraud risk indicators in journal entries: i, Posted to dormant/seldorn-used accounts ii, Posted by individuals who typically do not mak entries ii, Entries with scant or no explanation iv. Entries without appropriate supporting documentation (and for heaven's saka, internal memos from the CFO/CEO to the Financial manager are NOT appropriate supporting documentation for a journal entry! v._ Entries with round numbers Vi Entries which do not balance vi. Entries made at unusval times such as public holidays, weekends oF late at nigh’ vii. Entries for large Rand values (although itis not entirely tuncommon to post numerous journals for small amounts) 6, My lat litle helper, and by far my most favourite is the ‘application of an assertion | have innovatively named the “What the —" assertion (you may fill in the blank with any expletive of your choice). This assertion is genius as itrequites you to think le novel concept for some) and quastion the rationale ofthe journal entry or adjustment ~ was it necessary, does it make sense in light of the entity's activities, ts reporting framework, the ‘auditor's knowledge of the business...and so on and s0 forth [And my very very last word on the matter is one of caution - journal tertries and adjustments are a veritable landmine and auditors neo to tread with caution lest you become a victim. References Romero (lune 27 2002) “andal is stunning, vast and simple" ~ retvieved January he NY Times at website: http:/www.nytimes.com [December 8 2008) "Practice Ald for Test fant to AU Section ntre for audit qual Jeuinal Entries and 316" ~ retrieved January 14.2010 fror er Adjustments Pur http:/www.thecag.org Peter Grealy and Carolyn Young (21 Det fraud legal opinion by WW" - retrieved January 12 2010 from the Corporate Codes website at http:/www.corporatecodes.co.za asa