© 2003 by the AICPA SAS 99: Consideration of Fraud in a Financial Statement Audit

This presentation is intended for use in higher education for instructional purposes only, and is not for application in practice. Permission is granted to classroom instructors to photocopy this document for classroom teaching purposes only. All other rights are reserved. Copyright © 2003 by the American Institute of Certified Public Accountants, Inc., New York, New York.

© 2003 by the AICPA Overall Requirement An audit should be planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud. An audit requires due professional care, which in turn requires that the auditor exercise professional skepticism.

© 2003 by the AICPA Causes of Misstatements Causes Fraud Errors Misappropriation of Assets Financial Reporting

© 2003 by the AICPA Two Types of Fraud Considered in an Audit Fraudulent financial reporting (“cooking the books”)--examples Falsification of accounting records Omissions of transactions Misappropriation of assets--examples: Theft of assets Fraudulent expenditures

© 2003 by the AICPA Professional Skepticism An attitude that includes a questioning mind and a critical assessment of audit evidence The engagement should be conducted recognizing possibility of material misstatement due to fraud An auditor should not be satisfied with less than persuasive evidence

© 2003 by the AICPA Terminology Simplification To simplify the display, we will abbreviate the term used in the standard “risk of material misstatement due to fraud” as follows: Risk of material misstatement= Risk of fraud due to fraud

© 2003 by the AICPA Fraud Conditions (“Fraud Triangle) Incentive (Pressure) Opportunity Rationalization (Attitude)

© 2003 by the AICPA Steps involved in Considering the Risk of Fraud 1. Staff discussion 2. Obtain information needed to identify risks 3. Identify risks 4. Assess identified risks 5. Respond to results of assessment 6. Evaluate audit evidence 7. Communicate about fraud 8. Document consideration of fraud

© 2003 by the AICPA Step 1—Staff Discussion of the Risk of Fraud Brainstorm Consider how and where financial statements might be susceptible to fraud Exercise professional skepticism

© 2003 by the AICPA Step 2—Obtain information needed to identify risk of fraud Inquiries of management, the audit committee, internal auditors and others Consider results of analytical procedures Consider fraud risk factors Consider other information

© 2003 by the AICPA Step 3—Identify Risks that may Result in Fraud and Consider Type of risk Significance of risk (magnitude) Likelihood of Risk Pervasiveness of risk

© 2003 by the AICPA Step 4—Assess the identified risks after considering programs and controls Consider understanding of internal control Evaluate whether programs and controls address the identified risks Assess risks taking into account this evaluation

© 2003 by the AICPA Step 5—Respond to Results of the Assessment As risk increases Overall responses More experienced staff More attention to accounting policies Less predictable procedures Specific responses Consider need to increase evidence by altering the nature, timing and extent of audit procedures

© 2003 by the AICPA Step 5—Respond to Results of the Assessment (concluded) On all audits, the auditor should consider the possibility of management override of controls and examine: Adjusting journal entries Accounting estimates Unusual significant transactions

© 2003 by the AICPA Step 6—Evaluate Audit Evidence Assess risk of fraud throughout the audit Evaluate analytical procedures performed as substantive tests and at overall review stage Evaluate risk of fraud near completion of fieldwork Respond to misstatements

© 2003 by the AICPA Step 7—Communicate about Fraud Communicate All fraud to an appropriate level of management All management fraud to audit committee All material fraud to management and audit committee Determine if reportable conditions related to internal control have been identified; communicate them to the audit committee

© 2003 by the AICPA Document Consideration of Fraud Document steps 1 -7 Staff discussion Information used to identify risk of fraud Fraud risks identified Assessed risks after considering programs and controls Results of assessment of fraud risk Evaluation of audit evidence Communications requirements If improper revenue recognition was not considered a risk, why it wasn’t

© 2003 by the AICPA Question Number 1 What type of assurance is an audit planned and performed to obtain?

© 2003 by the AICPA Question Number 2 What is professional skepticism?

© 2003 by the AICPA Question Number 3 What are the two types of fraud addressed in an audit? Provide an example of each.

© 2003 by the AICPA Question Number 4 What 3 conditions are ordinarily present when individuals commit fraud?

© 2003 by the AICPA Question Number 5 In what area are analytical procedures required while planning the audit?

© 2003 by the AICPA Question Number 6 What is “management override?”

© 2003 by the AICPA Question Number 7 What are the required audit procedures in response to the possibility of management override?

© 2003 by the AICPA Question Number 8 What responsibility does an auditor have for communicating fraud to management and the audit committee?