Correct Answer Explanation

Management fraud refers to intentional deceptive practices carried out by individuals within an organization’s management or leadership team, aimed at manipulating financial statements or other business processes for personal gain.

It is a serious concern for companies and investors alike, as it can lead to significant financial losses and damage to the company’s reputation. The risk of management fraud can be influenced by various factors within an organization. Among the options provided, the correct answer is (d) Management incentive system based on sales done in a quarter.

(d) Management incentive system based on sales done in a quarter:

One of the primary reasons why this option increases the risk of management fraud is because it creates a potential conflict of interest for the management team.

When executives’ incentives are tied solely to short-term sales performance in a specific quarter, there may be a strong temptation for them to engage in fraudulent activities to artificially inflate sales figures.

This could involve tactics such as recognizing revenue too early, providing overly aggressive sales forecasts, or even engaging in fictitious sales transactions.

In such a scenario, managers may feel pressured to meet or exceed sales targets to secure their bonuses or other incentives, potentially leading them to compromise ethical standards.

This can result in financial statements that do not accurately represent the true financial health of the company, which can mislead investors, creditors, and other stakeholders.

Additionally, a focus on short-term sales performance may divert attention away from other crucial aspects of the business, such as product quality, customer satisfaction, and long-term sustainability. This can lead to a neglect of these areas, which may have negative consequences for the company in the long run.

Now, let’s evaluate the other options:

a) Frequent changes in supplies:

Frequent changes in supplies may increase operational complexity and require adjustments in procurement processes. While this can pose logistical challenges, it does not necessarily directly correlate with an increased risk of management fraud.

Supply chain changes can be managed through appropriate controls and monitoring mechanisms.

b) Improved internal control system:

An improved internal control system actually serves as a deterrent to management fraud. It involves implementing processes, policies, and procedures to safeguard company assets, ensure financial accuracy, and detect and prevent fraud.

Therefore, an enhanced internal control system reduces the risk of management fraud rather than increasing it.

c) Substantial increases in sales:

While substantial increases in sales can create added pressure on management to perform, it does not inherently increase the risk of management fraud. In fact, a company experiencing legitimate growth in sales should ideally have robust systems in place to manage this growth effectively.

It is more likely that a lack of controls and oversight in such a situation would elevate the risk of fraud, rather than the increase in sales itself.

In summary, the option (d) Management incentive system based on sales done in a quarter increases the risk of management fraud due to the potential conflict of interest it creates for the management team.

The other options do not directly contribute to an increased risk of management fraud and may even serve as safeguards against fraudulent activities when implemented properly.