Fraud Auditing. Chapter 11. Types of Fraud. Fraudulent financial reporting. Misappropriation of assets. The Fraud Triangle. Incentives/Pressures. Opportunities. Attitudes/Rationalization. Examples of Risk 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 Risk Factorsfor 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 Risk Factorsfor 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, or information technology staff exists
Examples of Risk Factorsfor Fraudulent Reporting Attitudes/Rationalization: • 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
Examples of Risk Factorsfor 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 Risk Factorsfor 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 Risk Factorsfor 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. SAS 1 states that, in exercising professional skepticism, an auditor “neither assumes that management is dishonest nor assumes unquestionedhonesty.”
Sources of Information Gatheredto Assess Fraud Risks Communication among audit team Inquiries of management Risk factors Analytical procedures Other information Identified risks of material misstatements due to fraud
Documenting Fraud Assessment • Discussion • Procedures • Specific risks • Reasons • Other conditions • Results • Nature of communications
Corporate Governance Oversightto 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 • Privacy and confidentiality
Organizational Factors Contributing to Risk of Fraud 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 Collusion between employees and management 15 19 23 Lack of control over management by directors 12 11 6 Ineffective or nonexistent ethics or compliance program 10 8 7 2003 1998 1994
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.
Rates of Fraud Occurrence Theft of assets 49 22 Check fraud 40 26 Expense account abuse 36 13 Credit card fraud 20 13 Payroll fraud 12 3 2003 1998
Rates of Fraud Occurrence Conflict of interest 12 9 Inventory theft 11 11 Kickbacks 9 6 Financial reporting fraud 7 3 2003 1998
Specific Fraud Risk Areas • Revenue and accounts receivable fraud risks • Inventory fraud risks • Purchases and accounts payable fraud risks • Other areas of fraud risk
Methods of Uncovering Fraud (Percentages) 2003 1998 1994 Internal controls Internal audit Notification by employee Accident Anonymous tip Notification by customer Notification by regulatory or law enforcement agency Notification by vendor External audit 77 65 63 54 41 34 19 16 12 51 43 58 37 35 41 16 11 4 52 47 51 28 26 34 8 15 5
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.
Types of Inquiry Techniques • Informational inquiry • Assessment inquiry • Interrogative inquiry • Evaluating responses • Listening techniques • Observing behavioral cues