Audit (CH10): Assessing and Responding to Fraud Risks
Terms in this set (44)
Fraudulent Financial Reporting
An intentional misstatement or omission of amounts or disclosures with the intent to deceive users
Form of earnings management that shifts income from year to year to reduce fluctuations
Misappropriation of Assets
Fraud that involves theft of an entity's assets. Normally perpetrated by lower level employees, but can involve upper management.
3) Attitudes/ Rationalization
Management or other employees have incentives or pressures to commit fraud
Circumstances provide opportunities for management or employees to commit fraud
An attitude, character, or set of ethical values exists that allows management or employees to commit a dishonest act, or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act.
Risk factors for Misappropriation of Assets
The same three conditions apply to misappropriation of assets. However, in assessing risk factors, greater emphasis is placed on individual incentives and opportunities for theft.
Auditing standards require that the audit be planned and performed with an attitude of professional skepticism
Professional Skepticism involves 2 components
1) Questioning Mind
2) Critical evaluation of audit evidence
Sources of Information to Assess Risks
1) Communication Among Audit Team
2) Inquiries of Management
3) Risk Factors
4) Analytical Procedures
5) Other information.
Identified Risks of Material Misstatement Due to Fraud
Auditors evaluate all of the sources of information to assess the risk of material misstatement due to fraud as part of audit planning.
The AICPA identifies 3 elements to prevent, deter, and detect fraud:
1) Culture of honesty and high ethics
2) Management's responsibility to evaluate risks of fraud
3) Audit committee oversight
Culture of Honesty and High Ethics
The most effective way to prevent and deter fraud is to implement antifraud programs and controls that are based on core values embraced by the company.
Setting the Tone at the Top
Honesty and integrity by management reinforces honesty and integrity by employees.
Creating a Positive Workplace Environment
Wrongdoing occurs less frequently when employees have positive feelings about their employer than when they feel abused, threatened, or ignored
Hiring and Promoting Appropriate Employees
To prevent fraud, companies implement screening policies and promote employees who are trustworthy
New employees should be trained about the company's expectations of employees' ethical behavior. Fraud awareness training should also be included.
Employees should periodically confirm their responsibilities for complying with the code of conduct.
Employees must know that they will be held accountable for failure the follow the code of conduct. Enforcement of violations of the code sends the message that compliance with the code is expected.
Identifying and Measuring Fraud Risks
Effective fraud oversight begins with management recognition that fraud is possible and almost any employee is capable of it.
Mitigating Fraud Risks
Management is responsible for implementing controls to mitigate fraud risks
Monitoring Fraud Prevention Programs and Controls
Management should periodically evaluate antifraud programs and ensure controls are effective. Internal audit plays a key role in monitoring.
Audit Committee Oversight
The audit committee has primary responsibility to oversee the organization's financial reporting and internal control process.
When an auditor identifies risks of material misstatements due to fraud, the auditor develops responses at 3 levels:
Overall Responses, Responses at the Assertion Level, Responses Related to Management Override.
Assign more experiences personnel to the audit or bring in a fraud specialist.
Responses at the Assertion Level
Changing the nature, timing, and extent of audit procedures
Response related to Management Override
- Examine journal entries and other adjustments for evidence of possible misstatements due to fraud
- Review accounting estimates for biases
- Evaluate the business rationale for significant unusual transactions.
Update Risk Assessment Process
The auditor's assessment of risk of material misstatement due to fraud is ongoing through the audit.
The auditor should be alert for the following conditions during the audit:
- Discrepancies in the accounting records
- Conflicting or missing audit evidence
- Problematic or unusual relationship between the auditor and management
- Results from substantive or final review stage analytical procedures that indicate a previously unrecognized fraud risk
- Responses to inquiries made throughout the audit that are vague or implausible or that produce evidence that is inconsistent with other information
Revenue and Accounts Receivable Fraud Risks
The Committee of Sponsoring Organizations (COSO) found that more than half of financial statement frauds involve revenue and accounts receivable, and related cash
3 main types of revenue manipulation are:
1. Fictitious revenues
2. Premature revenue recognition
3. Manipulation of adjustments to revenue
Warning signs of revenue fraud
- Analytical procedures
- Documentary discrepancies.
Misappropriation of Receipts involving Revenue
Rarely as material as fraudulent financial reporting, but is costly because it is a direct loss of assets (cash).
Failure to Record a Sale
One of the most difficult types of fraud to detect
Theft of Cash Receipts After a Sale is Recorded
To hide the theft, the perpetrator must reduce the customer's account in one of three ways:
1) Record a sales return or allowance
2) Write off the customer's account
3) Apply the payment from another customer to the customer's account
Inventory Fraud Risks
Fictitious inventory has been at the center of several major cases of fraudulent financial reporting
Warning Signs of Inventory Fraud
Analytical procedures, especially gross profit margin percentage and inventory turnover, are effective
Purchases and Accounts Payable Fraud Risks
Companies may deliberately attempt to understate accounts payable and overstate income.
Misappropriation in the Acquisition and Payment Cycle
The most common fraud in the acquisition area is for payments to be issued to fictitious vendors and depositing the cash in fictitious accounts.
Frauds are often detected by:
- Anonymous tips
- Management review
- Internal audit, or by accident
Use of Inquiry
Inquiry is an effective method of gathering more information and may take the following forms:
1) Informational inquiry
2) Assessment inquiry
3) Interrogative inquiry
For inquiry to be effective, the auditor must be skilled in:
- Evaluating responses to inquiry
- Listening techniques
- Observing behavioral cues
Other Responsibilities when Fraud is Suspected
Besides inquiry, the auditor may use any of the following procedures to determine whether fraud actually exists:
1) Audit software analysis
2) Expanded substantive testing
3) Consider other audit implications