Auditing and assurance services 14e by arens chapter 11

Learning Objective 1Define fraud and distinguish between fraudulent financial reporting and misappropriation of assets... Examples of Risk Factors for Fraudulent Reporting There are s

Fraud Auditing

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Learning Objective 1

Define fraud and distinguish between

fraudulent financial reporting and

misappropriation of assets.

Types of Fraud

Fraudulent financial reporting

Misappropriation

of assetsManagement

Fraud

Learning Objective 2

Describe the fraud triangle and identify

conditions for fraud.

The Fraud Triangle

Incentives/Pressures

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:

Examples of Risk Factors for Fraudulent Reporting

 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:

Examples of Risk Factors for Fraudulent Reporting

 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:

Examples of Risk Factors for Misappropriation of Assets

 There is a presence of large amounts of cash

on hand or inventory items

 There is an inadequate internal control over

assets

Opportunities:

Examples of Risk Factors for Misappropriation of Assets

 Disregard for the need to monitor or reduce

risk of misappropriating assets exists

 There is a disregard for internal controls

Attitudes/Rationalization:

Learning Objective 3

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 assumesunquestioned 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

Learning Objective 4

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

Example Elements for a Code of

Conduct

 Relationships with clients and suppliers

Gifts, entertainment, and favors

Kickbacks and secret commissions

Organization funds and other assets

Example Elements for a Code of

Conduct

 Organization records and communications

 Dealing with outside people and organizations

 Prompt communications

Organizational Factors Contributing to Risk of Fraud

Learning Objective 5

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 toaddress the risk of managementoverride of controls

Learning Objective 6

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

Learning Objective 7

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 gathersadditional information to determine whetherfraud actually exists

Initial Detection Method for Million-Dollar

Schemes

Tip

By Accident Internal Audit Internal Controls

External Audit Notified By Police

$1,000,000 +

Types of Inquiry Techniques

Informational

Assessment

Interrogative

Evaluating responsesListening

Observing

Observing Verbal Cues

Observing Non-Verbal Cues

End of Chapter 11