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Dear Kim,
Please consider the extract below (an audit risk) and explain how the profit could be overstated if the risk is payroll fraud and payroll may be overstated.
EXTRACT (202 KNIGHT ELECTRONICS CO; Kaplan Kit)
Audit Risk:
“During the year, a payroll clerk carried out
fraudulent transactions at the company
and there is a concern that additional
frauds may have taken place.There is a risk that the clerk may have
undertaken a significant level of
fraudulent transactions which have not
yet been identified, leading to an
increased control risk. Any additional
payments would need to be written off to
the statement of profit or loss. If these have
not been uncovered, profit and payroll
could be overstated.”My doubt is about the profit: if payroll expense is overstated as a result of the fraud, then profit should decrease and therefore be understated.
But the risk says profit is overstated.You are right, something is confusing here. If there is hidden expense i.e. still to be accounted for, further expense means that costs are currently UNDERstated and profit is currently overstated. These are the risks of misstatement.
Remember over/understatement concerns what is (currently) recorded v what needs to be recorded for the FS to be properly prepared (in all material respects).
If a business pays for goods/services that it does not receive, the cost is still incurred and has to be recorded somewhere. Incurring unnecessary costs is a business risk (not examinable per se in AA), it cannot be a RoMM if correctly recorded.
So this means currently (as at 1 july) the payroll expense, in particular, is overstated;
but as a result of the fact that more fraud may arise after investigations, it means the other expenses are understated, so profit is also overstated, presently (as at 1 July).I hope it makes sense.
Short answer no. There is a mistake in the answer as
it is not possible to have such a DR/CR misstatement. Profit is over if expense is under and vice versa.“which have not
yet been identified …. Any additional
payments would need to be written off ….”The answer is speculating…. IF further fraud is discovered …. there will be further expense -> less profit. Hence, the RoMM is expense (payroll) understatement -> profit overstatement.
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