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Fraud Auditing Chapter 11
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Types of Fraud Fraudulent financial reporting
Misappropriation of assets
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The Fraud Triangle Incentives/Pressures Opportunities
Attitudes/Rationalization
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Examples of Risks Factors for 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 Risks Factors for 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 staff.
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Examples of Risks Factors for Fraudulent Reporting
Attitudes/Rationalization Little communication and support of the entity’s core 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 Risks Factors for 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 Risks Factors for 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 Risks Factors for 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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Assessing the Risk of Fraud
SAS 99 provides guidance to auditors in assessing the risk of fraud.
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Professional Skepticism
SAS 1 states that, in exercising professional skepticism, an auditor “neither assumes that management is dishonest nor assumes unquestioned honesty.”
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Sources of Information Gathered to 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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Identify corporate governance
and other control environment factors that reduce fraud risks.
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Corporate Governance Oversight to Reduce Fraud Risks
1. Create and maintain a culture of honesty and high ethics. 2. Evaluate fraud risks and implement programs and controls to mitigate identified fraud risks. 3. Develop an appropriate fraud oversight process.
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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
2003 1998 1994 Collusion between employees and third parties Inadequate internal controls Management override of internal controls 48 31 33 39 58 59 36
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Organizational Factors Contributing to Risk of Fraud
Collusion between employees and management 15 19 23 Lack of control over management be 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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Specific Fraud Risk Areas
Revenue and accounts receivable fraud risks Inventory fraud risks Purchases and accounts payable fraud risks
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Methods of Uncovering Fraud
2003 1998 1994 Internal controls Internal audit Notification by employee 77% 51% 52% 65% 43% 47% 63% 58%
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Methods of Uncovering Fraud
Accident 54% 37% 28% Anonymous tip 41% 35% 26% Notification by customer 34% 41% 34% 2003 1998 1994
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Methods of Uncovering Fraud
Notification by regulatory or law enforcement agency 19% 16% 8% Notification by vendor 16% 11% 15% External audit 12% 4% 5% 2003 1998 1994
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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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End of Chapter 11
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