Question

What are the fraud risk factors of KCI, why are they risks, and how will the risk affect my approach to the audit of KCI?

King Companies, Inc. King Companies, Inc. (KCI) is a private company that owns five auto parts stores in urban Los Angeles, California. KCl has gone from two auto parts stores to five stores in the last three years, and it plans continued growth. Eric and Patricia King own the majority of the shares in KCI. Eric is the chairman of the board of directors of KCl and CEO, and Patricia is a director as well as the CFO.Shares not owned by Eric and Patricia are owned by friends and family who helped the Kings get started. Eric started the company with one store after working in an auto parts store. To date, he has funded growth from an inheritance and investments from a few friends. Eric and Patricia are thinking about expanding by opening three to five additional stores in the next few years. In October 2021, Eric approached your accounting firm, Thornson & Danforth LLP, to conduct an annual audit of KCl for the year ended December 31, 2022. KCl has not been audited before, but this year the audit has been requested by the company's bank because of anticipated bank loans and by a new private equity investor that has just acquired a 20% share of KCI. KCI employs 20 full-time staff. These workers are employed in store management, sales, parts delivery, and accounting. About 40% of KCI's business is retail walk-in business, and the other 60% is regular customers where KCl delivers parts to their locations and bills these customers on account. During peak periods, KCl also uses part-time workers. Eric is focused on growing revenues. Patricia trusts the company's workers to work hard for the company and she feels they should be rewarded well. The accounting staff, in particular, is very loyal to the company. Eric tells you that accounting staff enjoy their jobs so much they have never taken any annual vacations, and hardly any workers ever take sick leave. There are two people currently employed as accounting staff, the most senior of whom is Jonathan Jung. Jonathan heads the accounting department and reports directly to Patricia. He is in his late fifties and hopes to retire in two or three years and move away from Los Angeles. Jonathan keeps a close watch on accounting and does many activities himself, including opening mail, cash receipts and vendor payments, depositing funds received, performing reconciliations, posting journals, and performing the payroll function. His second employee, Abby Owens, is a recent college graduate who just passed the CPA exam. Abby is responsible for the payroll functions and posting all journal entries into the accounting system. Jonathan and Abby often help each other out in busy periods. Gather information: Identify and explain any significant fraud risk factors for KCI. BI UT TID 33 E 3 » 11 O Word(s) e Textbook and Media Analysis: For each fraud risk factor you identify, analyze how the risk will affect your approach to the audit of KCI.

Answer 1

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Answer: Fraud risk factors : Eric and patricia king have effective control, bor not lose ownership of the business. The presence of a new equity investor and the inddrement of the bank increase the domand for sxedible reports thanagement has a " laid Style, Suggesting there is not effective Control. There is also the question of effective control over assets because the cro a in control of financial Statements and is a major investor in the company The Chairman of the board is the hosband of the (Fo, the (FO is a director - is there good oversight. se, good corporate governance ? appears to be There 12 The accounts have not been audited before meaning that an independent external party has not presourly reviewed business's internal control and financal statements & opening balances are partiwlarly at risk. Staff Accounting tarce rarely there Vacation time, Suggesting has not been an opportunity to independently review thar work" Are they hiding anything 2 There appears with Segregation of duties and effective Supervision and monitoring. For or example, example, Tonathan Jonathan has talks of has the matting cash deposits and performing the bank reconoliation (these issues relate to oppostonity to commit fraud). Jonathan is close to retirement and thus har a short * horizon" in the business - Is there on attitude that he works so hard in the ccounting department th he is nowned Something Cre, an altitude) ratione

Is there effective supervision and / monitoring of the part time workers & They are people likely to have incentives for asser misappropriation due to their low wages. They could have an attitude that troud is reasonable due to the low wages Does the accounting Staff have proper procedures for processing these Short-term employment contracts ? who handles the HR duties 2 overall, the Small Size of the bosiness means it is unlikely that the client has fully effective internal Control Systems A great deal of reliance is placed on management Supervision and there are factors that indicate that this supervision might not be totally effective. Each fraud risk factor require more time in the audit plan to gather evidence about the assertions relating to relevant accounts and transactions. The plan would inclod time on understanding the client's system of internal Control, but additional conted desting would only be was where the Goditor intended to place reliance on the The frood risk factors appear to Soggest that greater sobstartive testing would be required, especially for accounts velating to payroll, bank accounts revenue recognition and expenses and closing entries. Fraud risk factor Explanation as to why a suggested audit approach Y1514 to address the risk. key accounting Statt There is no independent Little reliance should be not taking review of the work placed on internd contrds. vacation of the key accounting nore use of substantive staff which could testing of transactions lead to the statt and account balances misappropriating assets and not being detected balances reconciliation). by anyone Review onsual transactions con acavity. lie, payroll and bank

Fraud risk factor Explanation VISIK as to why a Weal lovlineffective internal controls poor segregation of accounting duties poor seg Supervision of statt poor business Managements Systems į processes. suggested audit approach to address the risk More substantive testing of transactions e balances, particularly revenuel accounts receivable, payroll ay accounts payable opening carried prior could be errors forward from Testing of balances. Opening balances have not been confirmed years. poor Corporate governance independence Risic of management overriding of controls (see AU-C issues 240-32) Test appropriateness of journal ledger entries Review of management. estimates and adjustments Review timing difference issues for recognition of Xeyeove y exper Sq -