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Chapter 4. Management Fraud and Audit Risk. 1. Errors, Fraud, and Noncompliance. Definitions Errors - unintentional Fraud (irregularities) - intentional Noncompliance with laws and regulations (Illegal acts)- violations of the law Auditor’s responsibilities

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Chapter 4


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chapter 4

Chapter 4

Management Fraud and Audit Risk

Chapter 3

1 errors fraud and noncompliance
1. Errors, Fraud, and Noncompliance
  • Definitions Errors - unintentional Fraud (irregularities) - intentional Noncompliance with laws and regulations (Illegal acts)- violations of the law
  • Auditor’s responsibilities
    • History Errors & Fraud: SAS 1, SAS 16, SAS 53, SAS 82, SAS 99 Illegal Acts: SAS 54

Chapter 3

1 errors fraud and noncompliance continued
1. Errors, Fraud, andNoncompliance (continued)
  • Errors and Fraud (AU-C 240)
    • design and conduct the audit to provide reasonable assurance that material errors and fraud will be discovered, and report the findings to appropriate parties
  • Noncompliance with laws and regulations (Illegal Acts) (AU-C 250)
    • direct effect noncompliance — same
    • indirect effect noncompliance — have general level of

awareness and act on those discovered

Questions

Chapter 3

1 errors fraud and noncompliance continued1
1. Errors, Fraud, and Noncompliance (continued)

Steps involved in Considering the Risk of Fraud

  • Staff discussion
  • Obtain information needed to identify risks
  • Identify risks
  • Assess identified risks
  • Respond to results of assessment
  • Evaluate audit evidence
  • Communicate about fraud (SAS 114)
  • Document consideration of fraud

Chapter 6

2 fraud
2. Fraud

Causes of Misstatements

Causes

ErrorsFraud

Misappropriation Fraudulent

of Assets Financial

Reporting

Chapter 3

2 fraud continued
2. Fraud (continued)

EXHIBIT 3.1

Chapter 3

2 fraud continued1
2. Fraud (continued)
  • Fraudulent financial reporting (cooking the books) (management fraud)
    • falsification of financial statements
    • falsification or omissions of transactions
  • Misappropriation of assets (employee fraud)
    • larceny
    • embezzlement

Chapter 3

2 fraud continued2
2. Fraud (continued)
  • Overview of Fraud (outline)
    • costs
    • discovery
    • victims
    • perpetrators
    • common characteristics
    • types

Chapter 3

the fraud triangle
The Fraud Triangle

PRESSURE

PERCEIVED

OPPORTUNITY

RATIONALIZATION

Summer 2009

2 fraud continued3
2. Fraud (continued)
  • Prevalence of fraud
  • Current frauds
  • Reasons to study fraud
  • Fraud related job opportunities
  • ACFE
  • CFE

Chapter 3

3 audit risk
3. Audit Risk

Chapter 3

3 audit risk1
3. Audit Risk
  • AU-C 320 – Audit Risk
  • General business risks
  • Engagement risk
  • Audit Risk Model
    • AR = RMM x DR
    • AR = IR x CR x DR
    • AR = IR x CR x TD x AP
  • Audit Risk definition
    • the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated
    • the danger that the auditor will fail to detect material misstatements in the financial statements
    • at financial statement level; at account balance level

Chapter 3

3 audit risk continued
3. Audit Risk (continued)
  • Risk of Material Misstatement
    • product of inherent risk and control risk
    • consider at entity level and account/assertion level
  • Inherent Risk
    • the susceptibility of an account balance to error assuming there are no controls
    • based on auditor’s judgment considering understanding of entity, nature of account (routine, systematic processing, complexity, etc), and fraud considerations
  • Control Risk
    • the risk that the ICS will not prevent or detect a material error on a timely basis
    • based on tests of control’s effectiveness

Chapter 3

3 audit risk continued1
3. Audit Risk (continued)
  • Detection Risk
    • the risk that the auditor’s procedures will not detect a material error
    • the product of Tests of Details Risk (TD) and Substantive Analytical Procedures Risk (AP)
    • Tests of Details Risk
      • the risk that tests of details will not detect a material error
    • Substantive Analytical Procedures Risk
      • the risk that analytical procedures (or other procedures that do not utilize sampling) will not detect a material error

Chapter 3

3 audit risk continued2
3. Audit Risk (continued)
  • Risks defined in negative
  • Auditor’s control over risks
  • Relationship between
    • RMM and DR
    • DR and amount of substantive testing

Chapter 3

3 audit risk continued3
3. Audit Risk (continued)
  • Subjectively considering Audit Risk
  • Quantifying Audit Risk
    • not required
    • DR = AR / IR x CR
    • TD = AR / IR x CR x AP

Questions

Chapter 3

3 audit risk continued4
3. Audit Risk (continued)
  • General guidelines
    • Inherent Risk
      • High > 60%
      • Moderate 40% - 60%
      • Low < 40%
    • Control Risk
      • Maximum = 100%
      • High > 70%
      • Moderate 40% - 70%
      • Low < 40%
      • Very Low < 10%

Chapter 3

3 audit risk continued5
3. Audit Risk (continued)
  • Analytical Procedures Risk
    • High > 50%
    • Moderate 20% - 50%
    • Low 10% - 20%
    • Very Low < 10%

Chapter 3

4 analytical procedures
4. Analytical Procedures
  • Definition
  • Uses in an audit
    • planning stage
    • as a substantive test (SAP)
    • final review stage
  • Required use

Chapter 3

4 analytical procedures continued
4. Analytical Procedures(Continued)
  • In planning stage
    • enhances auditor’s understanding
    • identifies risk areas
    • uses highly aggregated data
    • generally financial data

Chapter 3

4 analytical procedures continued1
4. Analytical Procedures(Continued)
  • Steps
    • develop an expectation
    • define a significant difference
    • calculate predictions and compare with recorded amount
    • investigate significant differences
    • document each step

Chapter 3

4 analytical procedures continued2
4. Analytical Procedures (Continued)
  • Substantive analytical procedures
    • based on level of DR
    • based on auditor judgment
    • balance sheet data vs. income statement data
    • often uses non-financial data

Chapter 3

4 analytical procedures continued3
4. Analytical Procedures(Continued)
  • In final evaluation stage
    • uses aggregated data
    • usually financial data
    • review same data used in planning stage

Questions

Chapter 3

5 review questions for discussion
5. Review Questions for Discussion
  • Chapter 4

4.6

4.7

4.8

4.9

4.12

4.14

4.17

Chapter 3