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Fraud Auditing. Chapter 11. Types of Fraud. Fraudulent financial reporting. Misappropriation of assets. The Fraud Triangle. Incentives/Pressures. Opportunities. Attitudes/Rationalization. Examples of Risks Factors for Fraudulent Reporting. Incentives/Pressures.
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Fraud Auditing Chapter 11
Types of Fraud Fraudulent financial reporting Misappropriation of assets
The Fraud Triangle Incentives/Pressures Opportunities Attitudes/Rationalization
Examples of Risks Factors for Fraudulent Reporting Incentives/Pressures 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.
Examples of Risks Factors for Fraudulent Reporting Opportunities There are significant accounting estimates that are difficult to verify. There is ineffective oversight over financial reporting. High turnover or ineffective accounting internal Audit staff.
Examples of Risks Factors for Fraudulent Reporting Attitudes/Rationalization Little communication and support of the entity’s core values is evident. A history of violations of laws is known. Management has a practice of making overly aggressive or unrealistic forecasts.
Examples of Risks Factors for Misappropriation of Assets Incentives/Pressures Personal financial obligations create pressure to misappropriate assets. Adverse relationships between management and employees motivate employees to misappropriate assets.
Examples of Risks Factors for Misappropriation of Assets Opportunities There is a presence of large amounts of cash on hand or inventory items. There is an inadequate internal control over assets.
Examples of Risks Factors for Misappropriation of Assets Attitudes/Rationalization Disregard for the need to monitor or reduce risk of misappropriating assets exists. There is a disregard for internal controls.
Assessing the Risk of Fraud SAS 99 provides guidance to auditors in assessing the risk of fraud.
Professional Skepticism SAS 1 states that, in exercising professional skepticism, an auditor “neither assumes that management is dishonest nor assumes unquestionedhonesty.”
Communication among audit team Inquiries of management Risk factors Analytical procedures Other information Identified risks of material misstatements due to fraud Sources of Information Gathered to Assess Fraud Risks
Identify corporate governance • and other control environment • factors that reduce fraud risks.
Corporate Governance Oversightto Reduce Fraud Risks 1. Create and maintain a culture of honesty and high ethics. 2. Evaluate fraud risks and implement programs and controls to mitigate identified fraud risks. 3. Develop an appropriate fraud oversight process.
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 Privacy and confidentiality
Collusion between employees and third parties 48 31 33 Inadequate internal controls 39 58 59 Management override of internal controls 31 36 36 2003 1998 1994 Organizational Factors Contributing to Risk of Fraud
Organizational Factors Contributing to Risk of Fraud Collusion between employees and management 15 19 23 Lack of control over management be directors 12 11 6 Ineffective or nonexistent ethics or compliance program 10 8 7 2003 1998 1994
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 identified risks. Design and perform procedures to address the risk of management override of controls.
Specific Fraud Risk Areas Revenue and accounts receivable fraud risks Inventory fraud risks Purchases and accounts payable fraud risks
Internal controls 77% 51% 52% Internal audit 65% 43% 47% Notification by employee 63% 58% 51% 2003 1998 1994 Methods of Uncovering Fraud
Methods of Uncovering Fraud Accident 54% 37% 28% Anonymous tip 41% 35% 26% Notification by customer 34% 41% 34% 2003 1998 1994
Methods of Uncovering Fraud Notification by regulatory or law enforcement agency 19% 16% 8% Notification by vendor 16% 11% 15% External audit 12% 4% 5% 2003 1998 1994
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.
