Chapter 1 – The Demand for Audit and Other Assurance · PDF file · 2013-03-05Design and perform audit procedures to address fraud risks. Design and perform procedures to address

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5

Fraud Auditing

Chapter 11


Learning Objective 1

Define fraud and distinguish between fraudulent financial reporting and misappropriation of assets.


Types of Fraud

Fraudulent financial reporting

Misappropriation of assets

Management Fraud



Describe the fraud triangle and identify conditions for fraud.


The Fraud Triangle

Incentives/Pressures

Opportunities Attitudes/Rationalization


Why Fraud Occurs


Examples of Risk Factors for Fraudulent Reporting

Financial stability or profitability is threatened by economic, industry, or entity operating conditions

Excessive pressure exists for management to meet debt requirements

Personal net worth is materially threatened

Incentives/Pressures:



There are significant accounting estimates that are difficult to verify

There is ineffective oversight over financial reporting

High turnover or ineffective accounting, internal audit, or information technology staff exists

Opportunities:



Inappropriate or inefficient communication and support of the entity’s values is evident

A history of violations of laws is known

Management has a practice of making overly aggressive or unrealistic forecasts

Attitudes/Rationalization:


Examples of Risk Factors for Misappropriation of Assets

Personal financial obligations create pressure to misappropriate assets

Adverse relationships between management and employees motivate employees to misappropriate assets

Incentives/Pressures:



There is a presence of large amounts of cash on hand or inventory items

There is an inadequate internal control over assets

Opportunities:



Disregard for the need to monitor or reduce risk of misappropriating assets exists

There is a disregard for internal controls

Attitudes/Rationalization:



Understand the auditor’s responsibility for assessing the risk of fraud and detecting material misstatements due to fraud.


Assessing the Risk of Fraud

SAS 99 provides guidance to auditors in assessing the risk of fraud.

SAS 1 states that, in exercising professional skepticism, an auditor “neither assumes that management is dishonest nor assumes unquestioned honesty.”


Sources of Information Gathered to Assess Fraud Risks


Documenting Fraud Assessment

Discussion among engagement team Procedures performed to assess risk Specific risks and audit response Reasons supporting conclusions Other conditions and analytical relationships Nature of communications



Identify corporate governance and other control environment factors that reduce fraud risks.


Corporate Governance Oversight to Reduce Fraud Risks

1. Culture of honesty and high ethics

2. Management's responsibility to evaluate risks of fraud

3. Audit committee oversight


Example Elements for a Code of Conduct

Organizational code of conduct General employee conduct

Conflicts of interest Outside activities, employment, and directorships



Relationships with clients and suppliers Gifts, entertainment, and favors

Kickbacks and secret commissions

Organization funds and other assets



Organization records and communications Dealing with outside people and organizations

Prompt communications Privacy and confidentiality


Organizational Factors Contributing to Risk of Fraud



Develop responses to identified fraud risks.


Responding to the Risk of Fraud

Change the overall conduct of the audit to respond to identified fraud risks.

Design and perform audit procedures to address fraud risks.

Design and perform procedures to address the risk of management override of controls.



Recognize specific fraud risk areas and develop procedures to detect fraud.


Specific Fraud Risk Areas

Inventory fraud risks

Revenue and accounts receivable fraud risks

Purchases and accounts payable fraud risks

Other areas of fraud risk


Effect of Fictitious Receivables on Accounting Ratios


Effect of Fictitious Inventory on Inventory Turnover



Understand interview techniques and other activities after fraud is suspected.


Responding to Misstatements That May Be the Result of Fraud

When fraud is suspected, the auditor gathers additional information to determine whether fraud actually exists.


Initial Detection Method for Million-Dollar Schemes

Tip

By Accident

Internal Audit

Internal Controls

External Audit

Notified By Police

$1,000,000+

All Cases

0% 10% 20% 30% 40% 50%

Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.

42.3%

46.2%

22.8%

20.0%

18.6%

19.4%

16.7% 23.3%

15.8% 9.1%

6.0%

3.2%

Type o

f D

ete

ctio

n


Types of Inquiry Techniques

Informational

Assessment

Interrogative

Evaluating responses

Listening

Observing behavioral cues


Observing Verbal Cues


Observing Non-Verbal Cues


End of Chapter 11

Documents

Chapter 1 – The Demand for Audit and Other Assurance · PDF file · 2013-03-05Design and perform audit procedures to address fraud risks. Design and perform procedures to address