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Fraud AuditingFraud Auditing
Chapter 11 Chapter 11
Types of FraudTypes of Fraud
Fraudulent financial reportingFraudulent financial reporting
Misappropriation of assetsMisappropriation of assets
The Fraud TriangleThe Fraud Triangle
Incentives/PressuresIncentives/Pressures
OpportunitiesOpportunities Attitudes/RationalizationAttitudes/Rationalization
Examples of Risks Factors for Examples of Risks Factors for Fraudulent ReportingFraudulent Reporting
Financial stability or profitability is threatened byFinancial stability or profitability is threatened byeconomic, industry, or entity operating conditions.economic, industry, or entity operating conditions.
Excessive pressure exists for management toExcessive pressure exists for management tomeet debt requirements.meet debt requirements.
Personal net worth is materially threatened.Personal net worth is materially threatened.
Examples of Risks Factors for Examples of Risks Factors for Fraudulent ReportingFraudulent Reporting
There are significant accounting estimates thatThere are significant accounting estimates thatare difficult to verify.are difficult to verify.
There is ineffective oversight over financialThere is ineffective oversight over financialreporting.reporting.
High turnover or ineffective accounting internalHigh turnover or ineffective accounting internalAudit staff.Audit staff.
Examples of Risks Factors for Examples of Risks Factors for Fraudulent ReportingFraudulent Reporting
Little communication and support of the Little communication and support of the entity’s core values is evident.entity’s core values is evident.
A history of violations of laws is known.A history of violations of laws is known.
Management has a practice of makingManagement has a practice of makingoverly aggressive or unrealistic forecasts.overly aggressive or unrealistic forecasts.
Examples of Risks Factors for Examples of Risks Factors for Misappropriation of AssetsMisappropriation of Assets
Personal financial obligations create pressure toPersonal financial obligations create pressure tomisappropriate assets.misappropriate assets.
Adverse relationships between managementAdverse relationships between managementand employees motivate employees toand employees motivate employees tomisappropriate assets.misappropriate assets.
Examples of Risks Factors for Examples of Risks Factors for Misappropriation of AssetsMisappropriation of Assets
There is a presence of large amounts of cashThere is a presence of large amounts of cashon hand or inventory items.on hand or inventory items.
There is an inadequate internal control overThere is an inadequate internal control overassets.assets.
Examples of Risks Factors for Examples of Risks Factors for Misappropriation of AssetsMisappropriation of Assets
Disregard for the need to monitor or reduceDisregard for the need to monitor or reducerisk of misappropriating assets exists.risk of misappropriating assets exists.
There is a disregard for internal controls.There is a disregard for internal controls.
Assessing the Risk of FraudAssessing the Risk of Fraud
SAS 99 provides guidance to auditorsSAS 99 provides guidance to auditorsin assessing the risk of fraud.in assessing the risk of fraud.
Professional SkepticismProfessional Skepticism
SAS 1 states that, in exercising professionalSAS 1 states that, in exercising professionalskepticism, an auditor “skepticism, an auditor “neither assumes thatneither assumes thatmanagement is dishonest nor assumesmanagement is dishonest nor assumesunquestionedunquestioned honestyhonesty..””
Sources of Information Gathered Sources of Information Gathered to Assess Fraud Risksto Assess Fraud Risks
CommunicationCommunicationamong audit teamamong audit team
Inquiries ofInquiries ofmanagementmanagement
RiskRiskfactorsfactors
AnalyticalAnalyticalproceduresprocedures
OtherOtherinformationinformation
Identified risks of material misstatements due to fraudIdentified risks of material misstatements due to fraud
Identify corporate governanceIdentify corporate governanceand other control environmentand other control environmentfactors that reduce fraud risks.factors that reduce fraud risks.
Corporate Governance OversightCorporate Governance Oversightto Reduce Fraud Risksto Reduce Fraud Risks1. Create and maintain a culture of honesty1. Create and maintain a culture of honesty and high ethics.and high ethics.
2. Evaluate fraud risks and implement programs2. Evaluate fraud risks and implement programs and controls to mitigate identified fraud risks.and controls to mitigate identified fraud risks.
3. Develop an appropriate fraud oversight process.3. Develop an appropriate fraud oversight process.
Example Elements for a Code of Example Elements for a Code of ConductConductOrganizational code of conductOrganizational code of conduct
General employee conductGeneral employee conduct
Conflicts of interestConflicts of interest
Outside activities, employment, and directorshipsOutside activities, employment, and directorships
Example Elements for a Code of Example Elements for a Code of ConductConductRelationships with clients and suppliersRelationships with clients and suppliers
Gifts, entertainment, and favorsGifts, entertainment, and favors
Kickbacks and secret commissionsKickbacks and secret commissions
Organization funds and other assetsOrganization funds and other assets
Example Elements for a Code of Example Elements for a Code of ConductConductOrganization records and communicationsOrganization records and communications
Dealing with outside people and organizationsDealing with outside people and organizations
Prompt communicationsPrompt communications
Privacy and confidentialityPrivacy and confidentiality
Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud
20032003 19981998 19941994
Collusion betweenCollusion betweenemployees andemployees and
third partiesthird partiesInadequateInadequate
internalinternalcontrolscontrols
ManagementManagementoverride ofoverride of
internal controlsinternal controls
484831313333393958585959313136363636
Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud
Collusion betweenCollusion betweenemployees andemployees and
managementmanagementLack of controlLack of control
over managementover managementbe directorsbe directors
Ineffective orIneffective ornonexistent ethics ornonexistent ethics orcompliance programcompliance program
15151919232312121111 661010 88 77
20032003 19981998 19941994
Learning Objective 5Learning Objective 5
Develop responses to identifiedDevelop responses to identifiedfraud risks.fraud risks.
Responding to the Risk of FraudResponding to the Risk of Fraud
Change the overall conduct of the auditChange the overall conduct of the auditto respond to identified fraud risks.to respond to identified fraud risks.
Design and perform audit proceduresDesign and perform audit proceduresto address identified risks.to address identified risks.
Design and perform procedures toDesign and perform procedures toaddress the risk of managementaddress the risk of managementoverride of controls.override of controls.
Specific Fraud Risk AreasSpecific Fraud Risk Areas
Inventory fraud risksInventory fraud risks
Revenue and accounts receivable fraud risksRevenue and accounts receivable fraud risks
Purchases and accounts payable fraud risksPurchases and accounts payable fraud risks
Methods of Uncovering FraudMethods of Uncovering Fraud
20032003 19981998 19941994
Internal controlsInternal controls
Internal auditInternal audit
NotificationNotificationby employeeby employee
77%77%51%51%52%52%65%65%43%43%47%47%63%63%58%58%51%51%
Methods of Uncovering FraudMethods of Uncovering Fraud
20032003 19981998 19941994
AccidentAccident
Anonymous tipAnonymous tip
NotificationNotificationby customerby customer
54%54%37%37%28%28%41%41%35%35%26%26%34%34%41%41%34%34%
Methods of Uncovering FraudMethods of Uncovering Fraud
20032003 19981998 19941994
Notification byNotification byregulatory or lawregulatory or law
enforcement agencyenforcement agency
NotificationNotificationby vendorby vendor
External auditExternal audit
19%19%16%16% 8%8%16%16%11%11%15%15%12%12% 4%4% 5%5%
Responding to Misstatements that Responding to Misstatements that May be the Result of FraudMay be the Result of Fraud
When fraud is suspected,When fraud is suspected,the auditor gathersthe auditor gathersadditional informationadditional informationto determine whetherto determine whetherfraud actually exists.fraud actually exists.
End of Chapter 11End of Chapter 11