Multiple Choice
Which of the following is an example of a detective control in the context of fraud prevention?
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6. Internal Controls and Reporting Cash
Fraud and the Fraud Triangle
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Why are the inventory and cost of goods sold (COGS) accounts attractive targets for managerial fraud?
A
Because changes in inventory and COGS have no impact on a company's financial statements.
B
Because these accounts are not subject to any internal controls or oversight.
C
Because these accounts often involve complex estimates and judgments, making it easier to manipulate reported profits.
D
Because inventory and COGS are always verified by external auditors in detail, reducing the risk of detection.
Verified step by step guidance1
Understand the role of inventory and COGS in financial statements: Inventory is an asset on the balance sheet, and COGS is an expense on the income statement. Changes in these accounts directly affect net income and profitability.
Recognize that inventory and COGS often involve estimates and judgments: For example, inventory valuation methods (e.g., FIFO, LIFO, or weighted average) and assumptions about obsolescence or shrinkage require managerial discretion.
Acknowledge the potential for manipulation: Managers may overstate inventory to reduce COGS, thereby inflating profits, or understate inventory to shift profits to future periods.
Understand the complexity of these accounts: The inherent complexity and reliance on estimates make it harder for auditors to detect manipulation, especially if internal controls are weak.
Conclude why these accounts are attractive for fraud: The combination of judgment-based estimates, direct impact on profitability, and potential difficulty in detection makes inventory and COGS attractive targets for managerial fraud.
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