Auditing Standards and the Credit and Collection Function

White collar crime involves financial theft that didn't involve violence or physical effort.  Credit fraud and other forms of white-collar crime are increasing in frequency and severity.  Combating these crimes will require the combined efforts of:

• All levels of management,
• The employees of the company,
• The company's independent auditors,
• The audit committee of the Board of Directors

To improve auditing standards regarding fraud detection and to provide additional guidance to auditors in this area, the Statement on Auditing Standards No. 82, "Consideration of Fraud in a Financial Statement Audit" (SAS 82) was implemented. It is the first auditing standard that specifically addresses financial fraud. It is also the first auditing standard that clearly establishes the independent auditor's responsibility regarding fraud detection as going beyond the audit planning process.  This auditing standard provides guidance on how CPAs are to assess fraud risk, including a discussion of specific risk factors that may affect the likelihood of fraud in a particular client. Independent auditors are required to conduct a reassessment of the risk of fraud at the end of the audit in light of all evidence gathered from the tests performed. SAS #82 also requires auditors to communicate to senior management and the board of directors regarding the existence of financial fraud, if it is found.

Under SAS 82, an independent auditor is required to plan and perform an audit to obtain reasonable assurance about whether financial statements are free of material misstatement. The auditor is required to consider forty-one risk factors relating to fraudulent financial reporting and misappropriation of assets when designing an audit plan.  In addition, the plan needs to be continuously modified during the audit on the basis of information gathered concerning these factors.

As it relates to the credit and collection function, auditors may focus on these areas or issues when performing their review for fraud:

• Whether adequate documentation relating to credit decisions is maintained,
• Whether credit granting authority is limited, and to whom and at what dollar level(s),
• Whether the A/R confirmations provided by customers fail to confirm the company's records relating to the amount customers owe,
• Whether the internal controls relating to establishing new accounts, assigning credit limits, invoicing customers, and posting payments received include adequate checks and balances,
• Whether or not the credit and collection department's decision makers are compensated based on financial targets such as increased sales,
• Whether the bad debt reserves are adequate, and how the company determines what is collectable and what should be reserved for and ultimately deemed uncollectable and written off to bad debt.

Financial statement fraud does not always involve data manipulation.  Failing to record transactions, such as liabilities or losses is simpler than falsifying financial statements by inserting false data.

Edited by Michael C. Dennis.  Michael is a business credit consultant and the author of four books including "Credit and Collection Forms and Procedures Manual."  Please visit his website at www.coveringcredit.com