Here you would identify and discuss the various accounting fraud that occurred at DHB Industries, Inc. (DHB). I would like you to discuss why DHB’s auditors were unable to prevent them from engaging in fraudulent activities. From an auditing standpoint, what audit procedures should DHB’s auditors have conducted to detect the fraudulent accounting by DHB’s management?

QUESTION

The suggested outline for the assignment is as follows:

• An introduction covering the background information of the case (1-2 paragraphs).

• Key issues of the case (about two pages).

Here you would identify and discuss the various accounting fraud that occurred at DHB Industries, Inc. (DHB). I would like you to discuss why DHB’s auditors were unable to prevent them from engaging in fraudulent activities. From an auditing standpoint, what audit procedures should DHB’s auditors have conducted to detect the fraudulent accounting by DHB’s management? One way you can approach this analysis is to identify the fraudulent accounting actions that occurred at DHB, and discuss the audit procedures that should have been followed to detect the fraud. You will find some discussion of the omitted audit procedures in the case. However, you should provide additional insights based on our class discussions and from other sources such as your textbook and auditing standards.

(3) Conclusion (1-2 paragraphs)

Include a cover page with your name on it. The report should not exceed three pages (double-spaced with sufficient margins), excluding the cover page. It should be formatted using Times New Roman 12-point font. Your name should appear on the cover page only (not included in the page limit). Please do not write your name on any other page.

ANSWER

 Accounting Fraud at DHB Industries, Inc.: An Analysis of Auditing Procedures

Introduction

DHB Industries, Inc. (DHB) was a manufacturer of body armor and other protective equipment for military and law enforcement personnel. This case analysis examines the accounting fraud that occurred at DHB and explores the reasons why the auditors were unable to prevent these fraudulent activities. By discussing the fraudulent accounting actions and identifying the necessary audit procedures, we can gain insights into the measures that should have been taken to detect the fraud.

Key Issues of the Case

The accounting fraud at DHB Industries involved several key issues that compromised the accuracy and reliability of the financial statements. These issues included:

Overstatement of Revenues: DHB inflated its revenues by recognizing sales prematurely or without proper documentation. This was achieved through fictitious sales, channel stuffing, and round-tripping transactions.

Misclassification of Expenses: Expenses were misclassified to manipulate the financial statements. For instance, certain expenses were improperly capitalized, leading to an overstatement of assets and understatement of expenses (Callen et al., 2008).

 Inventory Manipulation: DHB engaged in fraudulent practices related to its inventory. These practices included inflating inventory quantities and valuations, failure to write down obsolete inventory, and recording inventory that was not yet complete or saleable.

 Inadequate Disclosures: DHB failed to provide adequate disclosures regarding related-party transactions and contingent liabilities, which concealed potential risks and conflicts of interest.

Reasons for Auditor’s Failure to Detect Fraud

DHB’s auditors were unable to prevent the accounting fraud due to various reasons:

 Inadequate Risk Assessment: The auditors failed to properly assess the risks associated with DHB’s industry, such as the competitive environment and the potential for management override of controls. This limited their ability to identify areas vulnerable to fraud.

Lack of Professional Skepticism: The auditors did not exercise sufficient professional skepticism during their audit procedures (Hurtt et al., 2013). They accepted management representations at face value without conducting thorough substantive testing to validate the accuracy of financial statements.

 Inadequate Audit Procedures: The auditors did not perform comprehensive audit procedures that could have detected the fraudulent accounting actions at DHB. 

These procedures should have included:

   Analytical Procedures: Comparative analysis of financial data, trend analysis, and industry benchmarks could have revealed anomalies and inconsistencies that indicate potential fraud.

   Testing of Internal Controls: The auditors should have conducted a thorough evaluation of DHB’s internal controls, including a detailed assessment of key controls and their operating effectiveness (Performing Tests of Internal Controls Using Process Mining: What Could Go Wrong? – ProQuest, n.d.).

    Confirmation of Key Accounts: Confirmation requests sent directly to customers and suppliers would have validated the existence and accuracy of transactions and balances, uncovering fraudulent activities.

Conclusion

The accounting fraud at DHB Industries, Inc. highlights the importance of robust auditing procedures in detecting and preventing fraudulent activities. The auditors’ failure to detect the fraud can be attributed to inadequate risk assessment, lack of professional skepticism, and the omission of crucial audit procedures. By implementing comprehensive audit procedures, such as analytical procedures, testing of internal controls, and confirmation of key accounts, auditors can enhance their ability to uncover fraudulent accounting actions. Proactive measures in risk assessment and maintaining professional skepticism are vital to ensure the integrity of financial reporting.

References

Callen, J. P., Robb, S. W. G., & Segal, D. (2008). Revenue Manipulation and Restatements by Loss Firms. Auditing-a Journal of Practice & Theory, 27(2), 1–29. https://doi.org/10.2308/aud.2008.27.2.1 

Hurtt, K., Brown-Liburd, H. L., Earley, C. E., & Krishnamoorthy, G. (2013). Research on Auditor Professional Skepticism: Literature Synthesis and Opportunities for Future Research. Auditing-a Journal of Practice & Theory, 32(Supplement 1), 45–97. https://doi.org/10.2308/ajpt-50361

Performing Tests of Internal Controls Using Process Mining: What Could Go Wrong? – ProQuest. (n.d.). https://search.proquest.com/openview/8415e0c4eb862b145fa1d7b07dd7f9b3/1?pq-origsite=gscholar&cbl=41798