This part of the audit isn't exactly popular amongst the firms but I tell you—the task description will stun you from time to time. The absurdly enormous amount of money these directors are entitled to will make you want to kill them and wear their skin to work.
Directors' fees usually involve representation allowances for travel and clothing, entertainment, bonuses, and insurances. The audit consideration regarding this line item includes the questions: is this amount reasonable? Is this allowance subject to liquidation and are the liquidated receipts related to the job? Does this incentive program provide a motivation to commit fraud?
I once audited a company with hundreds of millions in assets that granted a 50 million performance incentive to its CEO. Further into the engagement, we discovered that he ordered the sales department to not document the sales discounts and understate selling commissions (in big trading firms, sales discounts and selling commissions actually reach up to 20-40% of the gross revenue) so that the gross profit for that year will appear to have reached the performance incentive threshold.
Given the cunning nature of the account, junior auditors aren't usually assigned to audit these fees. However, there was once an engagement with a newly established clothesline mall where I was assigned with no senior to oversee my work. Thus, I handled all the accounts myself. And there was the directors' fees hanging in the income statement before my eyes.
The thing was, the amount recorded was exactly 1/10 of the unadjusted gross sales.
It had irked me thoroughly. Auditors, although may not be math geniuses, have a thing for numbers. We have this feeling that things do not just coincide without a reason—that the existence of rental income gives rise to investment property not PPE, that if there is a salaries expense account then why is there no employee benefits account, that current tax provisions cannot be in whole numbers, so on.
To answer the issue, I first tried to understand the nature of the account. The incentive was fixed at 10% of sales every year according to the board resolution made at the inception of the company, payable (and paid) at the end of the year to the mall's President who was also the chairman of the board. Given that this particular clothesline mall was newly established (at that time, the mall had been open for only 3 years), one would expect either an operating loss or a meager net income. At that position, companies tend to grant smaller (if at all) directors' fees or incentives to its executives. So despite the fact that the mall's performance was way better than most, exactly 10% of the gross sales is still really big.
Was it reasonable? No.
Next course of action was to inspect the related documents for the fees. I expected either an official receipt for a car, or a travel ticket and accommodation expenses, or a check simply in the name of the mall's president. What I found bugged me. It was a lengthy list of groceries: biscuits, chips, flour, fruits, butter, cereal, lamb meat, turkey, so on. Totaling to exactly the 10% of gross sales. You might be professionally skeptic as to how they managed to exact the amount. Well, the purchaser had to purchase candies just so the total will zero in to the target.
Attached with the official receipt was a confirmation letter signed by the President stating that indeed he received the groceries contained in the OR. I was really bothered though, especially with the fact that during the planning meeting where the President conferred with my firm's partner, he openly stated that he and his family is allergic to pork.
I saw 500 kg. of pork in different cuts purchased in the OR.
As I raised the issue to my manager, she simply dismissed me stating that since the expense was duly supported by a board resolution and an official receipt then there was no issue as to its fairness. Our resort was to include the issue in our management letter, noting that as per our review the 10% incentive plan was not reasonable given the mall's profit capability.
I didn't pursue the topic afterwards. However, a year after that engagement I got assigned to the same mall again. I noticed they indeed ordered the cancellation of the board resolution. I talked to one of my colleagues regarding the mall and he sheepishly smiled. He said his brother used to work in the accounting office of that company. And he had heard the rumors surrounding that 10% incentive.
It wasn't an incentive. It was a tithe.
The story running around was that the president had a son who was born with reptilian scales. After his birth, the president had a vision that this son of his will bring forth income to the family. To ensure the flow of wealth, however, a 10% tithe is extracted from his businesses. The money was used to purchase food to appease the son who in turn secured their good fortune.
I had kept smiling as my friend recounted the rumor. We then shrugged the outrageous idea off.
At the middle of the second year audit engagement however, my initial analytical procedures discovered something out of place. Yes, there had been no 10% incentive the year after my first audit, but the company's litigation expenses suddenly ballooned. During the second year, the mall had faced a series of legal proceedings as evidenced by my review of their minutes and legal confirmation letters from their counsels. The proceedings were peculiarly similar: 6 female salesgirls and customers had disappeared during mall hours that year.
Maybe, just maybe, I had thought, their fountain of wealth finally grew tired of turkey.
