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Substantive Procedures – Asset Irregularities

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This next phase of the auditing process for Apollo Shoes Inc. (Apollo) is the designing of an audit program, which will detail substantive procedures for detecting irregularities in the accounts receivable, inventory, and fixed assets audit cycles. Fixed Assets

Apollo’s irregularities in fixed assets, has caused concern for substantive procedures to be designed to audit this cycle. The most common schemes where fixed assets are subject to manipulation include booking fictitious assets; misrepresenting asset valuation; and improperly capitalizing inventory and startup costs. One of the easiest methods of the misrepresentation of fixed assets is booking fictitious Assets. Booking fictitious assets affects account totals on a company’s balance sheet. This fraud can be overlooked because company assets are often physically found in many different locations. Another scheme is misrepresenting asset value. Fixed assets should be recorded at cost. If an assets appreciate in value, the increase should not be recognized on the company’s financial statements. Financial statement frauds involve the reporting of fixed assets at market values instead of the lower acquisition costs, or at even higher inflated values with phony valuations to support them. Companies also may falsely inflate the value of fixed assets by failing to record impairments of long-lived assets as required by FASB ASC 350.

Improperly capitalizing inventory and startup costs scheme are used by fraudsters in order to meet budget requirements. For example, once assets are misclassified into general ledger accounts where they do not belong, this manipulation can skew financial ratios and help comply with loan covenants or other borrowing requirements. The substantive procedures’ checklist that will be used to detect fixed assets schemes is as follows: Apollo’s financial reports indicate there are areas where fraudulent activity may exist. Depreciation of repairs and repainting of Apollo’s building is one of the largest area that presents potential fraudulent activity. The useful life of the building is 15 years, however, the repairs and repainting are being amortized over 30 years, and this represents a huge red flag.

These repairs and repainting should depreciated at the same rate as the building. Extending the depreciation period, causes profits to be overstated, this is a possible indicate of fraudulent activity. Inclusion of moving expenses and consulting services into the cost of the new computer system is another problem that indicates fraudulent activity may exist. Moving expenses and consulting services should have been reported and recorded when incurred. However, Apollo added the moving expenses and consulting services to the cost of the computer system, which will result in the overstatement of assets and net income. The substantive procedures’ checklist that will be used to detect fixed assets schemes is as follows: Substantive Tests for Fixed Assets Checklist

A. Presentation and Disclosure

[1] Read the financial statements in order to verify:
Disclosure of historical cost
Disclosure of depreciation methods under GAAP
Financial statement classification
Disclosure of restrictions

B. Valuation or Allocation

[1]Examine invoices
[2]Inspect lease agreements and ascertain the proper accounting treatment (e.g., capital vs. operating lease).
[3]Analyze repairs and maintenance accounts.
[4]Analyze related accumulated depreciation accounts.
[5]Vouch entries in fixed asset accounts.
[6]Test extensions and footings on client-submitted schedules

C. Completeness

[1] Perform analytical procedures
[2] Inspect fixed assets
[3] Examine subsidiary schedules
[4] Reconcile subsidiary schedules with general ledger control

D. Existence or Occurrence

[1]Inspect fixed assets.
[2]Examine supporting documentation.

E. Rights and Obligations

[1]Inspect invoices
[2]Inspect lease agreements
[3]Inspect insurance policies
[4]Inspect title documents
[5]Inspect personal property tax returns
[6] Read minutes of the board of directors’ meetings

F. Related Income Statement Effects

[1]Recalculate depreciation expenses.
[2]Recalculate gain or loss on disposal of fixed assets.

Louwers, T. J., Ramsay, R. J., Sinason, D. H., & Strawser, J. R., & Thibodeau, J. C. (2011). Auditing & assurance services (4th ed.). New York, NY: McGraw-Hill/Irwin. Accounting Financial & Tax, 2014. Substantive Testing: Cash, Receivables, Inventory and Fixed Assets. Retrieved from: http://accounting-financial-tax.com/2010/05/substantive- testing-cash-receivables-inventory-and-fixed-assets/

University of Phoenix (2013). Apollo Shoes Casebook Web-Based. Retrieved November 15, 2014 from University of Phoenix Assignments. ACC/556 – Forensic
Accounting. Wells, J. (2011). Principles of fraud examination (3rd ed.). Hoboken, NJ: Wiley. http://www.csulb.edu/~mdchase/500CashandInternalControl.pdf

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