CHAPTER 15:

ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE BUSINESS ENTITY

● Define business entity

Business Entity refers to an organization created by one or more individuals, whether a
natural or legal person,to carry out the functions of a business, engage in a trade, or partake in
similar activities.
● Transaction Cycles

Example of simple transaction cycle:

● 3 BASIC BUSINESS TRANSACTION CYCLES

1.Sales and Collections Cycle
2.Acquisition and Payments Cycle
3.Payroll and Personnel Cycle

● Errors and irregularities in the transaction cycles of the business entity

 Intro: As a sort of recap, let’s try first to differentiate error from fraud.

I.SALES AND COLLECTIONS CYCLE

1.Errors in Recording Sales and Collections Transactions

- Includes mechanical errors, such as using a wrong piece or wrong quantity,
recording sales in the wrong period and bookkeeper’s failure to understand
proper accounting for a transaction, and many more.
- As discussed on Basic Financial Accounting and Reporting, there are
errors that an accountant or accounting staffs may commit which
considered unintentional.
- An example of it is data entry errors. Herein, items could be entered
in a wrong account, instead of recording unearned revenue it is entered
on the revenue account. There are also instances that an
amount’s digits is being transposed. Another one, an accounting staff may also
commit an error when it comes to journalizing, it may be duplicated or
omitted if the invoices are left mishandled.
- To sum it up, those errors even considered deemed unintentional, still
have an effect to the the company’s financial reports.

2. Frauds in Sales and Collections

- Frauds in Sale: Generally related to fraudulent financial reporting
a. Typically done by managers that aim to achieve high profits, inflating
sales or understating sales returns and allowances in order to meet
target profits.

Examples:
 ● Recording fictitious sales- when we say fictitious sales, it refers to those
sale of goods or services that did not occur. In that case, a fictitious invoice
can be prepared for a legitimate customer even though goods are not
delivered or services have not been rendered. 
● Recording valid transactions twice- under this, the accounting staff
intentionally records a sale twice so that the total sales may seem more
higher.
● Recording in the current period sales that occurred in the succeeding
period - Again, in accordance with matching principle, revenues are
recognized in the period when it is earned, regardless of when it is receive.
Let me give an example, On January 30, a seller sells goods to buyer X on
FOB destination. On February 2, buyer X received the goods. In this case,
the accountant or accounting staff should record the sale once that the buyer
already receives the goods. However, in this particular case, the staff
intentionally record the sale on January 30.
● Recording operating leases as sales- Herein, a lessor should only record
a lease payments as income if the period is already consumed by the
lessee. To reiterate, revenues are recognized in the period when it is
earned, regardless of when it is receive.
● Recording deposits as sales- like what I’ve said before
● Recording consignment as sales- Under consignment, goods are left in
the possession of an authorized third party to sell. A consignee should only
record sales once the goods held by the consignor have been sold.
● Following revenue recognition practices that are not in accordance
with PFRS- At the present, PFRS is the accounting standard being
followed. Thus, entity’s which are required to conformed with the said
standard should use it in reporting financial statements.
● Recording revenue that should be deferred- Again, there are revenue
that is earned through a period of time, and recognizing those revenue at the
period when the cash is received will result to overstatement of the current
period and understatement of future periods.

- Frauds in Collections: related to misappropriation of assets, typically

accomplished by clerks or management-level employees
1. Skimming - act of withholding cash receipts even without recording them.
-Sam is the owner of a hot dog stand. Recently, he hired a
new employee. After two weeks, Sam discovered that the
hot dog stand’s revenues decreased by 40%.
After analyzing the business’ accounting records, he found
out that his new employee did not always use the cash register for
hotdog sales. He did not give receipts to customers who purchased only
a hot dog or drink and paid in cash. Also, the customers usually did not
ask for receipts because the amounts were small. At the same time, Sam
could not detect the fraud from his accounting books because the
transactions were never recorded.
- Based on my experience while working on a carenderia, this
type scheme was really evident . So, At the end of the day, there
is an inventory check, the total cash is matched with the inventory.
However, the records for extra rice, is not covincing considering
that there are always many customers and many of those is ordering
extra rice. Later on, my tita found out that the cashier is not
recording the extra rice on the receipts for the carenderia,
considering that the customers is also not demanding receipts.
- Detecting unrecorded cash receipts is very difficult,
however certain changes in the gross profit or sales
volume can be an indication that cash receipts have
been withheld.
2. Lapping- technique used to conceal the fact that cash has been abstracted;
the shortage in one customer’s account is covered with a subsequent
payment by another customer.
- In other words, this scheme begins when someone
steals money that was generated by a transaction (for
example, a sale). This individual offsets the missing money
using cash from the next transaction. The receivable from
this second transaction is covered by money from the
third transaction, etc.
- To illustrate, suppose Gene, a cashier for store ABC,
processes a sale for P500. He puts the cash in his pocket.
Gene's next customer purchases P1,000 of
merchandise. Rather than use this customer's
payment toward the corresponding P1,000
receivable, he uses P500 to satisfy the P500 receivable
from the first customer and uses the remaining P500
to partially offset the open P1,000 receivable from
the second customer.
- This kind of fraud can be uncovered through routine
testing of details of collections compared with
validated bank deposit slips.
3. Kiting- technique used to cover cash shortage or to inflate cash balance.
- It involves counting the cash twice by using the float in
the banking system.
- It works like this. Instead of depositing all of the
company income checks, a bookkeeper can cash one of
the checks for him and put it in his own bank account.
Since the company needed this cash to pay bills, the
company checking account will overdraft without these
funds. The bookkeeper then writes a check to cover the
bills knowing that the account will be in overdraft. Before
the check has a chance to clear, the bookkeeper writes
another check from a different company account into the
main company account. This buys the bookkeeper a few
more days until the second check can clear. By that
time, more deposits will come in and the funds can be
replaced, no overdraft fees will occur, and the
bookkeeper can embezzle another deposit.
- This kind of fraud can be revealed by means of
analyzing and verifying cash transfers during the
days surrounding the year-end.