1. SAS 99: Consideration of Fraud in a Financial Statement Audit

2. 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.

3. Causes of Misstatements Causes Errors Fraud Fraudulent Misappropriation Financial of Assets Reporting

4. Types of Fraud—multiple choice Which of the following describe situations involving misappropriation of assets? a. An accounts receivable clerk steals customer payments and writes them off as sales returns and allowances. b. A controller directs staff to record journal entries to recognize revenue as production lots are completed rather than when they are shipped because sales are virtually assured for the products. c. A purchasing manager receives a large gift from a key supplier after signing a contract to purchase parts from the supplier for the next two years. d. All of the above involve misappropriation of assets e. Both a. and c. above involve misappropriation of assets.

5. 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

6. 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

7. 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

8. Fraud Conditions (“Fraud Triangle”) Incentive (Pressure) Opportunity Rationalization (Attitude)

9. 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

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

11. 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

12. Step 3—Identify Risks that may Result in Fraud and Consider Type of risk Significance of risk (magnitude) Likelihood of Risk Pervasiveness of risk

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. Major Initiatives of SAS No. 99 Emphasis of the importance of professional ____________ The use of the fraud __________ as a way to understand the risk factors associated with fraud Emphasis of the importance of _________ of fraud among audit team members, with client personnel, and others. Expanded operational guidance on how to respond the increased risk of fraud—step # _____ Emphasis of the importance of considering ___________ ___________ fraud.