13.19 In identifying risks of material misstatement due to fraud, it is help-ful for the auditor to consider the information that has been gathered in accor-dance with the requirements of paragraphs .19 through .34 of AU section 316.i The auditor's identification of fraud risks may be influenced by characteristics
aSee footnote a in paragraph 13.01.
iAU section 316.19–.34 can be found in AICPAProfessional Standards and PCAOB Standards and Related Rules.
Consideration of Fraud in a Financial Statement Audit
83
such as the size, complexity, and ownership attributes of the entity. In addition, the auditor should evaluate whether identified risks of material misstatement due to fraud can be related to specific financial-statement account balances or classes of transactions and related assertions, or whether they relate more pervasively to the financial statements as a whole. Certain accounts, classes of transactions, and assertions that have high inherent risk because they involve a high degree of management judgment and subjectivity also may present risks of material misstatement due to fraud because they are susceptible to manip-ulation by management.
13.20 For example, in addition to their susceptibility to misappropriation, inventories of cooperatives and producers may be subject to fraudulent finan-cial reporting involving the valuation and allocation assertion. Although the availability of reliable purchase or market prices may alleviate this concern, determination of net realizable value or lower-of-cost-or-market can be subjec-tive and will often involve managerial estimates.
13.21 Equipment and other fixed assets are also vulnerable to misappro-priation, but like inventory they can pose a risk of fraudulent financial reporting involving the valuation and allocation assertion. In particular, natural compet-itive pressures and changes in production technology make careful evaluation of possible impairment losses a critical management responsibility in the coop-erative and producer environment. Given the broad range of factors that can influence this determination, estimation of any loss is likely to be highly subjec-tive. The presentation and disclosure assertion may be relevant as well since impairment losses are reported in part according to management's plans for the underlying assets' use or disposition. For example, the producer may have a line of equipment unique to the harvesting of a particular crop. The market for the crop may have disappeared from the local area due to the closure of a processing plant. The producer will be sustaining the burden of switching to another crop, needing to acquire another line of equipment. The existing equipment may be idled, with no local or regional market for disposal of the equipment. The creditor's collateral may be impaired, even though the equip-ment is in good working condition. Apart from the possibility of such losses is the need to consider the impact of any asset retirement obligations that may ex-ist with respect to property, plant, and equipment. Depending on the nature of the obligation, FASB Statement No. 143, Accounting for Asset Retirement Obli-gations, requires producers and cooperatives to estimate a fair value‡ of the related liability for accrual and capitalization (and thus subsequent deprecia-tion) purposes. Accordingly, rights and obligations becomes another assertion of possible audit concern in this area.
13.22 Valuation and allocation will again be an assertion of primary au-ditor interest in the area of cooperative investments, as will presentation and disclosure. Concern here is likely to center on carrying values and the effects of investee losses and unallocated equities. In this regard, management's inter-pretation and application of the relevant authoritative literature (e.g., APB
‡ In June 2004, the FASB published an exposure draft of a proposed Statement, Fair Value Mea-surements, which seeks to establish a framework for measuring fair value that would apply broadly to financial and nonfinancial assets and liabilities, improving the consistency, comparability, and reliabil-ity of the measurements. The fair value framework would clarify the fair value measurement objective and its application under authoritative pronouncements that require fair value measurements. The exposure draft would replace any current guidance for measuring fair value in those pronouncements and would expand current disclosures. A final Statement is expected to be issued in the third quarter of 2006.
Opinion No. 18) will require careful auditor consideration. The timing and recognition of patronage dividends may pose similar concerns. Furthermore, management's discretion in displaying patronage refunds suggests the need for auditor scrutiny since presentation choices (e.g., reductions of costs and ex-penses) made without adequate supporting disclosure may distort operating results.
13.23 The unique characteristics of cooperatives give rise to concern for the presentation and disclosure assertion in another financial statement area, specifically patrons' equities. In addition to determining that classifications are consistent with the underlying economic realities, the auditor should ascertain that allocated equities have been determined in accordance with the coopera-tive's bylaws and any statutory requirements. In this regard, the auditor should also consider the existence of due dates or interest obligations that would sug-gest the need to reclassify patronage allocations as debt, thus, causing both valuation and allocation and rights and obligations assertions to become of greater audit concern.||
13.24 In the case of agricultural producers, integrated livestock and row crop operations are particularly challenging to audit due to financial charac-teristics unique to the operations. Crops raised may be fed to the livestock, hiding crops diverted by employees. Thus, with respect to key assertions, the auditor will want to emphasize both the existence and completeness of these in-ventories, as well as their classification—presentation and disclosure assertion.
Records of units harvested compared to livestock pounds sold may indicate feed conversion ratios out of line with industry standards. Each agricultural pro-ducer uses land for unique purposes depending upon crop rotation, geographic limitations, soil type, weather conditions, livestock integration, etc. It is this
"uniqueness" that makes auditing agricultural producers particularly difficult.
The auditor needs to use information gathered from sources other than internal records to determine which crops were raised on which ground, to determine expectations for quantities harvested. Comparisons with the producer's histor-ical results may be the better indicator of current problems. "Common size"
financial information (classification on a per acre or per unit harvested) may also disclose anomalies.
A Presumption That Improper Revenue Recognition Is a Fraud Risk 13.25 Material misstatements due to fraudulent financial reporting often result from an overstatement of revenues (for example, through premature revenue recognition or recording fictitious revenues) or an understatement of revenues (for example, through improperly shifting revenues to a later period).
Therefore, the auditor should ordinarily presume that there is a risk of material misstatement due to fraud relating to revenue recognition (See paragraph .41 of
||Some agricultural cooperatives may have retained allocated equities which are usually repaid to cooperative patrons over a specific number of years. These retained allocated equities may meet the definition of mandatorily redeemable financial instruments under FASB Statement No. 150, Ac-counting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and as such may have to be classified as liabilities. However, in accordance with FASB Staff Position (FSP) FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instru-ments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, the mandatorily redeemable provisions of FASB Statement No. 150 and all related FSPs for non-public entities are deferred indefinitely, pending further FASB action, if the redemption date is not fixed or if the payout amount is variable and not based on an index. Readers should be alert to further developments.
Consideration of Fraud in a Financial Statement Audit
85
AU section 316j). Due to the nature of agriculture, improper revenue recognition is possible related to crop revenue.
13.26 Agricultural cooperatives and producers are increasingly using derivatives and other complex contracts for marketing agricultural commodi-ties and for hedging associated risks. Some of these contracts include embedded derivatives or derivative-like features. In some cases, neither top management nor the accounting staff fully understand these contracts, related risks and the associated accounting ramifications. Improper accounting for such activities can easily result in income being moved between fiscal periods.
13.27 Significant year-end revenue accruals may be based on estimates and management judgments. Special audit attention should be given to the reasonableness of such revenue accruals. Quantity, quality and value of year-end commodity inventories, particularly those stored in bulk form, are subject to numerous estimates. The misstatement of inventory does not directly affect revenue, but it has a direct effect on cost of sales and periodic earnings. For example, the value of the inventory of livestock will depend upon the health of the animals, weight and estimated costs of disposal for animals of market size. The auditor needs to have the experience to evaluate the various factors that affect the value of inventory or consider using a specialist to evaluate the estimates provided by management (see AU section 336, Using the Work of a Specialist [AICPA, Professional Standards, vol. 1; AICPA, PCAOB Standards and Related Rules]). Commodities in storage are also subject to manipulation by management. Merely computing the volume of grain in storage is not sufficient to establish the bona fides of the value. Grain placed at the top of the bin may be of high quality, hiding substandard grain subject to substantial dockage.
13.28 In addition to timing of revenue recognition, timing and consistency of expense recognition can be used to manipulate results of operations. For ex-ample, the decision to expense or capitalize certain expenditures can be made inconsistently from one year to the next for the purpose of smoothing net in-come. Expense accruals and allowances can likewise be used to manipulate net income.
A Consideration of the Risk of Management Override of Controls 13.29 Even if specific risks of material misstatement due to fraud are not identified by the auditor, there is a possibility that management override of controls could occur, and accordingly, the auditor should address that risk (see paragraph .57 of AU section 316k) apart from any conclusions regarding the existence of more specifically identifiable risks. Specifically, the procedures de-scribed in paragraphs .58 through .67 of AU section 316lshould be performed to further address the risk of management override of controls. These proce-dures include (1) examining journal entries and other adjustments for evidence of possible material misstatement due to fraud, (2) reviewing accounting esti-mates for biases that could result in material misstatement due to fraud, and (3) evaluating the business rationale for significant unusual transactions.
j AU section 316.41 can be found in AICPA Professional Standards and PCAOB Standards and Related Rules.
k AU section 316.57 can be found in AICPA Professional Standards and PCAOB Standards and Related Rules.
l AU section 316.58–.67 can be found in AICPA Professional Standards and PCAOB Standards and Related Rules.
Key Estimates
13.30 The following significant estimates are common in agricultural co-operatives and producers: