1. Learning Objectives LO1 Differentiate among frauds, errors, and illegal acts that might occur in an organization. LO2 Explain the auditing standards related to external, internal, and governmental auditors’ responsibilities to detect and report frauds, errors, and illegal acts. LO3 Outline some of the conditions that lead to frauds. LO4 Explain the audit procedures for detecting common employee fraud schemes. LO5 Explain the audit procedures for detecting common fraudulent financial reporting. LO6 Describe documents that auditors use for fraud risk assessment and detection. 1

2. Auditors’ Responsibilities  Auditors have the responsibility “to obtain reasonable (i.e., high) assurance whether the financial statements are free of material misstatements,” including misstatements due to fraud. LO2 2

3. Auditors’ Responsibility to Consider Fraud and Error in an Audit of Financial Statements-CAS/ISA 240 The auditor shall make inquiries of management regarding: (a) Management’s assessment of the risk that the financial statements may be materially misstated due to fraud, including the nature, extent and frequency of such assessments; (b) Management’s process for identifying and responding to the risks of fraud in the entity, including any specific risks of fraud that management has identified or that have been brought to its attention, or classes of transactions, account balances, or disclosures for which a risk of fraud is likely to exist; LO2 3

4. Auditors’ Responsibility to Consider Fraud and Error in an Audit of Financial Statements-CAS/ISA 240 The auditor shall make inquiries of management regarding: (c) Management’s communication, if any, to those charged with governance regarding its processes for identifying and responding to the risks of fraud in the entity; and (d) Management’s communication, if any, to employees regarding its views on business practices and ethical behaviour. LO2 4

5. Auditors’ Responsibility to Consider Fraud and Error in an Audit of Financial Statements-CAS/ISA 240 CAS 240 requires auditors maintain professional skepticism, and ignore the traditional assumption of management’s honesty. LO2 5

6. How does the auditor justify that the fraud risk is low?  Perform analytical procedures of revenues, make enquiries, and scan for unusual entries (especially at year-end),  The audit team should have brainstorming sessions to identify and share information on fraud risk factors during the audit.  Identify biases in management accounting estimates and be able to understand the business rationale of transactions. If the auditors cannot justify that the fraud risk is low, then they need to raise the matter with the audit committee LO2 6

7. Illegal Acts by Auditees Direct-effect illegal acts have direct and material effects on financial statement amounts and they are dealt with in the same manner as errors and irregularities. Indirect-effect illegal acts refer to violations of laws and regulations that are far removed from financial statements. LO2 7

8. Illegal Acts by Auditees  CAS 250 requires auditors to consider the consequences of the illegal acts very broadly, and the best way of disclosing these.  If failures to disclose would result in a material misstatement, then the auditor should attempt to reduce this risk to an appropriately low level.  CAS 250 acknowledges that illegal acts may be difficult to detect because of (1) efforts made to conceal them and (2) questions about whether an act is illegal, which are complex and may only be resolved by a court of law. LO2 8

9. Illegal Acts by Auditees  The auditors’ knowledge of the business and enquiries of management help to identify laws and regulations that, if violated and not reported, could result in material misstatements.  In addition, auditors should enquire and obtain representations about awareness and disclosure of possibly illegal acts.  Material, possibly illegal, acts should be communicated to the audit committee and appropriate levels of management LO2 9

10. Auditing Accounting Estimates and Fair Value Accounting Accounting estimates are an approximation of a financial statement element, item, or account made by an organization’s management.  The auditor shall also evaluate the adequacy of the disclosure of their estimation uncertainty.  The auditor shall review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias. LO2 10

11. Communication with Audit Committees (or Equivalent) CAS 260 requires oral or written communication from the auditors on the following: (a) misstatements other than trivial errors; (b) fraud; (c) misstatements that may cause future financial statements to be materially misstated; (d) illegal or possibly illegal acts, other than ones considered inconsequential; and (e) significant weaknesses in internal control. LO2 11

12. Materiality and Fraud The auditors should inform the audit committee of all suspected fraud and illegal acts, except those that are “clearly inconsequential.” Those involving senior management are never inconsequential. LO2 12