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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. Learning Objective 2. Describe the fraud triangle and

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Fraud auditing l.jpg

Fraud Auditing

Chapter 11


Learning objective 1 l.jpg
Learning Objective 1

  • Define fraud and distinguish

  • between fraudulent financial

  • reporting and misappropriation

  • of assets.


Types of fraud l.jpg
Types of Fraud

  • Fraudulent financial reporting

  • Misappropriation of assets


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Learning Objective 2

  • Describe the fraud triangle and

  • identify conditions for fraud.


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The Fraud Triangle

Incentives/Pressures

Opportunities

Attitudes/Rationalization


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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


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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


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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


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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


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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


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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


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Learning Objective 3

  • Understand the auditor’s

  • responsibility for assessing

  • the risk of fraud and detecting

  • material misstatements due to

  • fraud.


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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.”


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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


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Documenting Fraud Assessment

  • Discussion

  • Procedures

  • Specific risks

  • Reasons

  • Other conditions

  • Results

  • Nature of communications


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Learning Objective 4

  • Identify corporate governance

  • and other control environment

  • factors that reduce fraud risks.


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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


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Example Elements for a Code of Conduct

  • Organizational code of conduct

  • General employee conduct

  • Conflicts of interest

  • Outside activities, employment, and directorships


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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


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Example Elements for a Code of Conduct

  • Organization records and communications

  • Dealing with outside people and organizations

  • Prompt communications

  • Privacy and confidentiality


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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


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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


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Learning Objective 5

  • Develop responses to identified

  • fraud risks.


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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.


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Learning Objective 6

  • Recognize specific fraud risk

  • areas and develop procedures

  • to detect fraud.


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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


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Rates of Fraud Occurrence

Conflict of interest

12

9

Inventory theft

11

11

Kickbacks

9

6

Financial reporting

fraud

7

3

2003

1998


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Specific Fraud Risk Areas

  • Revenue and accounts receivable fraud risks

  • Inventory fraud risks

  • Purchases and accounts payable fraud risks

  • Other areas of fraud risk


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Learning Objective 7

  • Understand interview techniques

  • and other activities after fraud

  • is suspected.


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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


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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.


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Types of Inquiry Techniques

  • Informational inquiry

  • Assessment inquiry

  • Interrogative inquiry

  • Evaluating responses

  • Listening techniques

  • Observing behavioral cues



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