Detecting frauds related to inventory items on financial statements of nonfinancial companies listed on vietnam’s stock market

Nội dung text: Detecting frauds related to inventory items on financial statements of nonfinancial companies listed on vietnam’s stock market

1. DETECTING FRAUDS RELATED TO INVENTORY ITEMS ON FINANCIAL STATEMENTS OF NON- FINANCIAL COMPANIES LISTED ON VIETNAM’S STOCK MARKET Ta Thu Trang*1 - Doan Thanh Nga ABSTRACT: Inventories are considered to be material items and are often abused to commit fraudulent activities in preparing financial statements. The paper has used a combination of qualitative and quantitative research methods through a survey of 113 experienced auditors and SPSS software to conduct statistical description of fraud risk indicators (red flags) and effectively audit procedures to identify frauds related to inventory items in preparing financial statements of non-financial companies listed on the Vietnam’s stock market. Keywords: Fraudulent financial reporting, inventory, fraud risk indicators, audit procedures, non-financial companies listed on Vietnam’s stock market. 1. INTRODUCTION According to the Association of Certified Fraud Examiners, annual financial loss for the total world product value caused by financial frauds is approximately $ 3.7 trillion (ACFE, 2012 and ACFE, 2014). In particular, fraudulent financial reporting is fraud causing damage with approximately 10 times more than misappropriation of assets. Surveys of professional associations found that inventories accounted for a significant proportion and were often abused by companies in making fraudulent financial reporting. Specifically, The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has conducted two fraudulent investigations related to fraudulent financial reporting of listed companies. According to their statistic reports, Frauds involving overstatements of assets (including inventories) accounts for about 50% of fraud cases (COSO, 1999, COSO, 2010). In Vietnam, DFK Auditing Company has not detected inventory shortage of nearly 1,000 billion VND of Truong Thanh Furniture Corporation in 2016 (Minh Chau, 2016); A&C Auditing Company and E&Y Auditing Company did not detect any fraudulent behavior through transferring inventories with related parties to generate ficticious revenue of Vien Dong Pharmaceutical Company in 2008 and 2009 (Ngoc Thuy, 2011; Khanh Linh, 2011). Consequently, detecting fraud related to inventory items in preparing financial statements is a challenge for auditors. This leads to information risks for users of financial statements. This paper is intended to provide evidence of fraudulent risks related to inventory items on financial statements and supporting auditors in designing effective audit procedures to detect fraud and reduce audit risks for audit firms. 2. LITERATURE REVIEW 2.1. International researches Internationally, there are some researches focused on the design of audit procedures for detecting frauds related to inventory items in financial statement audits. In particular, Moyes (1997), Owusu- * National Economics University, Hanoi, Vietnam National Economics University, Hanoi, Vietnam
2. INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION 427 Ansah et al (2002) proposed 56 audit procedures for fraud detection in inventory audit. Of which, there are 14 audit procedures which are the most effective procedures in detecting fraud, including reviewing transactions with related parties; monitoring of resolved exceptions to inventories; reviewing procedures in inventory physical examination; confirmation related to inventory; physical examination; Then, there are 27 effective audit procedures at moderate level and 15 remaining audit procedures are not effective in detecting fraud. Alleyne et al. (2010), based on the research of Owusu-Ansah et al., conducted a testing of 56 audit procedures in detecting frauds related to inventory item. The result reveals that the most effective audit procedures were 21 audit procedures, which were much better than the procedures in the study by Owusu-Ansah et al. (2002). The author provides a number of highly effective audit procedures, such as: observation of the inventory counting, reconciliation between inventory list and counting result, For audit procedures with moderate level of effectiveness, 9 auditing procedures (compared to 27 procedures in the Owusu-Ansah study) and 26 less effective audit procedures. However, the results of the study show that audit procedures collecting direct audit evidence (substantive tests) are more effective than audit procedures collecting indirect audit evidence (using documents of the audited entity). 2.2. Vietnamese researches Research in Vietnam on evaluating fraudulent indicators and fraud detection procedures for inventory in financial statement audits is relatively limited. In particular, Dao Minh Hang (2016) conducted a research on inventory audit in financial audits at steel companies conducted by independent auditing firms. The author has made a combination of quantitative and qualitative research methods to assess the factors affecting inventory audits and the differences between auditing firm groups in practicing audit of inventory to enhance techniques of collecting auditing evidences and improving audit process for auditing inventories in financial statements audit. Nguyen Thi Lan Anh (2017) conducted a study on inventory audit in the audit of financial statements by independent auditors. In the study, the author proposes effective audit procedures based on 56 audit procedures provided by Moyes (1997), Owusu-Ansah et al. (2002), Alleyne et al. (2010). The author argues that highly effective audit procedures involve the search for direct evidence of fraudulent behavior from clients. However, studies in the world and in Vietnam do not find out fraudulent indicators associated with inventory items, which will be a basis for designing effective audit procedures for detecting fraud related to inventory. Based on the research gap in the world and Vietnam, the authors conducted a combination of qualitative and quantitative methods to identify common fraudulent indicators associated with inventory items and effective audit procedures in identifying that fraudulent risk indicators. 3. THEORETICAL BACKGROUND The fraudulent behaviors associated with inventory in preparing financial statements are diverse and complex. Specially, for companies listed on the stock market, inventory is often overstated in value and quantity of inventory. • Exaggerating inventory value: Fraudulent behaviour associated with inventory overstatements is often done in ways, such as fictitious inventories and the use of accounting estimates. Firstly, fictitious inventories: Counterfeiting inventory behaviours include creating fictitious inventory counting records, fictitious invoices in the purchase process but actually, the goods could be borrowed from
3. 428 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA another entity or the goods are not in stock; performing asset transferring among related parties by issuing invoices but the actual goods may still exist in the third party warehouses. Secondly, the asset value is overstated by accounting estimates to exceed inventory value. Particularly, the accountant strives to postpone allowance for decline in inventories to help the company reducing expense and overstating assets value. Thirdly, overstating purchased inventory through trading. For example, companies intentionally exaggerate the unit price or made a round tripping of inventory with subsidiaries or related parties to increase the purchasing price of inventory or the companies made a change in the method of calculation of dispatching inventory price over periods to increase or decrease inventory value. • Exaggerating inventory quantity: Fraud related to exaggerating inventory quantity by changing the quantity of inventories in counting records, organizing inventory counting twice for the same inventory at different times, overblowing quantity of goods in transit, receiving inventory in consignment but recording as company’s inventory, exaggerating the quantity of inventory consigned to the third parties. By assessing method of committing fraud related to inventory, auditors could realize some fraudulent risk indicators, such as: there are large number of transactions of trading inventory from related parties at the end of accounting year, or there is a phenomenon of selling inventory to related parties at the end of the accounting year and re-purchase of inventory at the beginning of the next accounting year; the average balance and number of days of storage increased dramatically in comparison with previous year; the ratio of inventory balance exceeded inventory norm; the company has a large quantity of re-purchasing inventory after the balance sheet date; regularly changing the accounting policy of allowance for decline in inventories, regularly changing the method of calculating the price of dispatching inventory. Regarding to form of fraud, audited entities often leave fraudulent indicators on items in financial statements. When the auditor identifies fraudulent indicators, it is necessary to response to these fraudulent risk indicators at management assertion level and at financial statements as a whole level. Specially, for fraud risks in preparing financial statements, the auditor should increase performing substantive tests. In this study, based on fraud risk for inventory items, the authors design audit procedures for detecting fraudulent actions associated with overstating the value and quantity of inventory. 4. RESEARCH METHODS The authors use a combination of qualitative and quantitative methods. For qualitative methods, the authors conducted semi-structured interviews for 6 experienced auditors with more than 10 years of experience to identify common fraudulent indicators for inventory items and effective audit procedures in detecting fraud in preparing financial statements of non-financial companies listed on Vietnam’s stock market. Based on a review of previous studies in the world and in Vietnam, the authors conducted a quantitative research by sending 400 questionnaires to surveyed auditors with auditing experience for listed companies. The number of questionnaires received was 113, equivalent to 113 respondents. The experience of auditors surveyed mainly equals to 5 year experiences or more, accounted for 80% of the total number of questionnaires received. The authors have designed questionnaires and measured the prevalence of fraudulent indicators and the effectiveness of audit procedures through the Likert scale from 1 to 5 points (1-point is completely unpopular/ completely ineffective, 2-point is not common/ ineffective, 3-point is common/ effective (moderate), 4-point is very popular/ very effective, 5-point is completely popular/ completely effective).
4. INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION 429 5. RESEARCH RESULTS 5.1. Descriptive statistics results of fraudulent indicators for inventory items Through the results of the survey, the authors point out the common fraudulent indicators of overstating inventories as follows: The most important and common fraudulent risk is the large quantity or irregular purchase of inventory from related parties at the end of accounting period or the occurrence of sale and re-purchase of inventory with related parties, which has the highest average score (3.57 points). The average balance and number of days of storage increased dramatically at the end of accounting period, and the ratio of inventory balance exceeded inventory norm whereas many inventories did not fluctuate over many accounting periods have the same average score (3.25 points). The average rating is the regularly changing the accounting policy of allowance for decline in inventories, which has average score of approximately 3 points. The score of the indicator “regularly changing the method of calculating the price of dispatching inventory” was the lowest (2.83 points). Table 1. Statistical description of fraudulent indicators of overstating inventory items Fraudulent indicators of overstating Number of Minimum Maximum Average Standard inventory items observations score score value deviation The large quantity or irregular purchase of inventory from related parties at the end of accounting period or the 113 1 5 3.57 0.990 occurrence of sale and re-purchase of inventory with related parties The average balance and number of days of storage increased dramatically at the 113 1 5 3.25 0.915 end of accounting period The ratio of inventory balance exceeded inventory norm whereas many inventories did not fluctuate over many 113 1 5 3.25 1,061 accounting periods The company has a large quantity of re- purchasing inventory after the balance 113 1 5 3.20 1.054 sheet date Regularly changing the accounting policy of allowance for decline in 113 1 5 2.96 1.243 inventories Regularly changing the method of calculating the price of dispatching 113 1 5 2.83 1.273 inventory. Valid N (listwise) 113 (Source: Results from the authors’ study) 5.2. Descriptive statistics results of designing effective audit procedures for detecting fraud related to inventory items Based on fraudulent indicators of fraud, auditor designs and performs effective audit procedures to detect fraud related to inventories, as follows: Firstly, effective audit procedures to detect fraud related to overstatement of inventory purchase price
5. 430 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA Carefully reconciling purchase prices on contracts, purchase invoices of related parties with those of independent third parties in the same industry is an important audit procedure (3.6 points). The transfer pricing between parent companies and subsidiaries or special purpose enterprises is a common phenomenon in listed companies. Confirmation to suppliers is evaluated at low level of effectiveness (3.37 points) because the companies has collusion with related parties to transfer losses or profits to subsidiaries or special purpose enterprises. Therefore, the technique of sending a confirmation letter is not evaluated as effective audit procedure in this case. Table 2. Descriptive statistics results of the effectiveness of audit procedures for detecting fraud related to exaggerating inventory purchasing price Audit procedures for detecting fraud Number of Minimum Maximum Average Standard related to exaggerating inventory observations score score value deviation purchasing price Reconciling purchase prices of transactions with related parties with those of independent third parties in the same industry to identify 113 2 5 3.60 0.801 transfer pricing indicators. Checking purchasing prices on contracts and reconciling purchase prices on contracts with purchasing invoices, and 113 1 5 3.49 1.044 with independent purchasing prices on the market Confirmation to suppliers 113 1 5 3.37 1.032 Valid N (listwise) 113 (Source: Results from the authors’ study) Secondly, effective audit procedures to detect fraud related to round tripping of inventory The nature of this transaction is that the company performs round tripping of inventory with related parties or special purpose enterprises and then the parent company re-purchases. The parent company uses its subsidiaries or special purpose enterprises to sell inventory at high prices or re-purchases or re-leases them at low prices. Therefore, auditors appreciated the effectiveness of the procedure of checking the selling price and re-purchasing to identify transfer pricing risk in these transactions (3.73 points). The audit procedure of reconciling contract prices with price lists approved by the board of directors for asset re-purchase and verifying information on related parties regarding the source of ownership of inventory to determine the nature of the sale and re-purchase of inventory (over 3.6 points). However, physical examination of available inventory, checking code of inventory which was sole just prior to the balance sheet date, and checking the asset code that was sole right after the balance sheet date; verifying the customer list and supplier list to identify any coincidence in buying and selling the same inventory are procedures which were assessed at lower level of effectiveness (3.5 points). Due to complication of these transactions and inventory is transferred to many subsidiaries or special purpose enterprises (there is little transaction between only two companies), especially, for inventory items that are frequently sold and re-purchased, it is difficult for auditors to identify this fraud of round tripping.
6. INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION 431 Table 3. Descriptive statistics results of audit procedures for detecting fraud in round tripping of inventory with related parties Audit procedures for detecting fraud Number of Minimum Maximum Average Standard in round tripping of inventory with observations score score value deviation related parties Checking the selling price and re- purchasing to identify transfer pricing 113 1 5 3.73 0.877 risk Reconciling contract prices with price lists approved by the board of directors 113 2 5 3.64 0.942 for asset re-purchase transactions Verifying information on related parties regarding the source of ownership of inventory to determine 113 1 5 3.61 0.942 the nature of the sale and re-purchase of inventory Verifying the customer list and supplier list to identify any coincidence in 113 2 5 3.50 0.821 buying and selling the same inventory Physical examination of available inventory, checking code of inventory which was sole just prior to the balance 113 2 5 3.50 1.042 sheet date, and checking the inventory code that was sole right after the balance sheet date Valid N (listwise) 113 (Source: Results from the authors’ study) Thirdly, effective audit procedures to detect fraud related to exaggerating inventory quantity All audit procedures in detecting exaggerating inventory quantity are assessed at high level of effectiveness (over 3.5 points). In which, confirmation with third parties about inventory in consignment and collecting evidence of the existence of the third party (3.69 points) and checking goods returned to the supplier right after the end of the accounting year (3.62 points) are assessed at high level of effectiveness. However, implementation of additional procedures in the process of inventory physical examination and verifying documents proving the ownership of the inventory, separation between inventory owned by the company and those under third parties’ ownership are only assessed at an average score of 3.52 points. Table 4. Descriptive statistics results of the effectiveness of audit procedures for detecting fraud related to exaggerating inventory quantity Audit procedures for detecting fraud Number of Minimum Maximum Average Standard related to exaggerating inventory observations score score value deviation quantity Confirmation with third parties about inventory in consignment and collecting 113 1 5 3.69 0.952 evidence of the existence of the third party
7. 432 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA Checking goods returned to the supplier right after the end of the accounting year 113 1 5 3.62 0.888 without appropriate reason Physical examination without notice of inventory at one location or multiple 113 1 5 3.59 1.066 locations on the same day. Implementing additional procedures in the process of inventory counting observation, even hiring experts to perform the valuation 113 1 5 3.52 0.920 of inventory with specific technical characteristics. Verifying documents proving the ownership of the inventory, separation between 113 1 5 3.52 1.053 inventory owned by the company and those under third parties’ ownership Valid N (listwise) 113 (Source: Results from the authors’ study) Fourthly, effective audit procedures to detect fraud related to allowance for decline in inventories Auditors should collect more outside information, such as market selling price at the time of evaluation, market forecasts of agencies and market news to estimate the allowance rate for decline in inventories (3.63 point). However, substantive analytical procedures and hiring experts for supporting in constructing an estimation model to allow for decline in inventories were assessed with an average score of 3.29 points. Table 5. Descriptive statistics results of the effectiveness of audit procedures for detecting fraud related to allowance for decline in inventories Audit procedures for detecting fraud Number of Minimum Maximum Average Standard related to allowance for decline in observations score score value deviation inventories Collecting information related to market selling price at the time of evaluation, market forecasts of agencies and market 113 1 5 3.63 0.876 news to estimate the allowance rate for decline in inventories Checking for changes in accounting policies related to judgments and assumptions of accounting estimates. Comparing the changes in company’s 113 1 5 3.53 0.917 accounting policies with current regulations, and with industrial targets. Performing substantive analytical procedures, even hiring experts for supporting in constructing an estimation 113 1 5 3.29 0.942 model to allow for decline in inventories Valid N (listwise) 113 (Source: Results from the authors’ study)
8. INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION 433 CONCLUSION The results of the investigation on fraudulent indicators and identifying the effective audit procedures for detecting frauds associated with inventory reveals that auditor has performed flexibly audit procedures, such as inspection, confirmation, analytical procedures, without following standard audit program rigidly. Based on the fraudulent associated with inventory, the research results support auditors and audit firms not only in designing a system of fraudulent indicators at management assertion level but also in designing audit program, including key audit procedures for each fraudulent indicators. Research results are also important training materials for new audit assistants in detecting frauds associated with inventory items on financial statements. Based on red flags at management assertion level, auditor must assess fraud risk at management assertion level and design effective audit procedures to detect frauds related to inventory. REFFERENCE Alleyne, P., Persaud, N., Alleyne, P., Greenidge, D., and Sealy, P. (2010), ‘Perceived effectiveness of fraud detection audit procedures in a stock and warehousing cycle: Additional evidence from Barbados’, Managerial Auditing Journal, Vol. 25, No. 6, pp. 553-568. Association of Certified Fraud Examiners (2012), ACFE Report to the Nations on Occupational Fraud and Abuse, Austin, TX: Author, 2012 Association of Certified Fraud Examiners (2014), ACFE Report to the Nations on Occupational Fraud and Abuse, Austin, TX: Author, 2014 Committee of Sponsoring Organization (COSO) (1999), Fraudulent Financial Reporting: 1987-1991- An Analysis of US. Public Companies. Website address: Committee of Sponsoring Organization (COSO) (2010), Fraudulent Financial Reporting: 1998-2007- An Analysis of US. Public Companies. Website address: Dao Minh Hang (2016),Research on inventory audit in financial statement audit of steel manufacturing enterprises conducted by independent audit firms in Vietnam, PhD. Thesis, Thuongmai University.’ Khanh Linh (2011), Vụ việc DVD: Trách nhiệm của công ty kiểm toán đến đâu?, date: 20/9/2017, at: dvd-67785/vu-viec-dvd-trach-nhiem-cua-cong-ty-kiem-toan-den-dau.chn Minh Chau (2016), ‘Kiểm kê thiếu hụt gần 1.000 tỷ tại Gỗ Trường Thành: Trách nhiệm của công ty kiểm toán DFK Việt Nam thế nào?, date: 20/10/2017, at: http: thanh-trach-nhiem-cua-cong-ty-kiem-toan-dfk-viet-nam-the-nao-20160802224133432.chn Moyes, G.D (1997), ‘Audit techniques and inventory fraud detection in accounting information systems’, Review of Accounting Information Systems, Vol. 1, No. 1, pp. 63-76. Ngoc Thuy (2011), Quy lỗi kiểm toán trong vụ DVD: Phải đợi sau ngày 27/10, date: 28/10/2017, at: https:// tinnhanhchungkhoan.vn/chung-khoan/quy-loi-kiem-toan-trong-vu-dvd-phai-doi-sau-ngay-2710-38053.html Nguyen Thi Lan Anh (2017), Inventory audit in financial statement audit conducted by independent audit firms in Vietnam, PhD Thesis, National Economics University. Owusu-Ansah, S., Moyes, G. D., Babangida Oyelere, P., and Hay, D. (2002), ‘An empirical analysis of the likelihood of detecting fraud in New Zealand’, Managerial Auditing Journal, Vol. 17, No. 4, pp. 192-204.