Lakeside Case Study

Fraud Risk - Profit-Sharing Bonus System

Issue(s): A bonus system based on profit, could incentivize Lakeside Company’s employees to manipulate financial information for their own potential personal gain. Each location under Lakeside will be working towards increasing their profits so they receive the biggest bonus possible. Since their internal controls are weak, this increases the possibility of this fraud. However, it is important to mention that the predecessor auditor believed that the people at Lakeside, that they worked with, are people of integrity. This type of positive organizational culture tends to decrease potential fraud risk.

Possible Manipulation: The employees at Lakeside could manipulate sales revenue and increase it so that

Auditors must perform an occurrence test to determine if this fraud was committed. They could do this by checking bills of lading, sales invoices, channel stuffing and even communicating with some of the purchasers of Lakeside’s products. To receive the bonus, the ending inventory could have been over counted so as to reduce the amount of inventory charged to cost of goods sold; thus, increasing profits. The auditor must perform an existence test to determine whether this inventory is actually on hand. Liabilities could have been understated so as to decrease expenses and increase profits; consequently, also increasing the bonus. The auditor must test for completeness. This means the auditor should check whether the expenses they incurred are actually accounted for. They could do this by checking whether expense recognition was wrongly deferred and/or if expenses have been capitalized when they shouldn’t have. To test for this overall fraud risk in more depth, the auditor may be necessitated to include more experienced staff to sit on the audit team to collect additional evidence. This will potentially take longer; thus, costing Lakeside more

When returning inventory to suppliers, returns could be overstated or recorded in an earlier period. When the inventory is being sold it may be recorded at too low of an amount, cost of goods may not be recorded at all and inventory may not be reduced accordingly. Items could become obsolete and instead of writing it down/off the employees may just take it. It didn’t mention whether Lakeside performs valid, internal periodic counts. If they lack this internal control this could allow employees to steal inventory. The employees could hide this inventory shrinkage by double counting inventory. A company could also falsify purchase orders, shipping reports and even label boxes as inventory when they are actually empty. Furthermore, understating ending inventory would reduce taxes as it reduces the company’s