©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 11 - 1 Fraud Auditing Chapter 11

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens/Elder/Beasley Arens/Elder/Beasley 11 - 1

Fraud AuditingFraud Auditing

Chapter 11Chapter 11

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 11 - 11 - 22

Types of FraudTypes of Fraud

Fraudulent financial reporting

Misappropriation of assets


The Fraud TriangleThe Fraud Triangle

Incentives/Pressures

Opportunities Attitudes/Rationalization


Examples of Risk FactorsExamples of Risk Factorsfor Fraudulent Reportingfor Fraudulent Reporting

Financial stability or profitability is threatened byeconomic, industry, or entity operating conditions

Excessive pressure exists for management tomeet debt requirements

Personal net worth is materially threatened

Incentives/Pressures:



There are significant accounting estimates thatare difficult to verify

There is ineffective oversight over financialreporting

High turnover or ineffective accounting, internalaudit, or information technology staff exists

Opportunities:



Inappropriate or inefficient communicationand support of the entity’s values is evident

A history of violations of laws is known

Management has a practice of makingoverly aggressive or unrealistic forecasts

Attitudes/Rationalization:


Examples of Risk FactorsExamples of Risk Factorsfor Misappropriation of Assetsfor Misappropriation of Assets

Personal financial obligations create pressureto misappropriate assets

Adverse relationships between managementand employees motivate employees tomisappropriate assets

Incentives/Pressures:



There is a presence of large amounts of cashon hand or inventory items

There is an inadequate internal control overassets

Opportunities:



Disregard for the need to monitor or reducerisk of misappropriating assets exists

There is a disregard for internal controls

Attitudes/Rationalization:


Assessing the Risk of FraudAssessing the Risk of Fraud

SAS 99 provides guidance to auditorsin assessing the risk of fraud.

SAS 1 states that, in exercising professionalskepticism, an auditor “neither assumes thatmanagement is dishonest nor assumesunquestioned honesty.”


Sources of Information GatheredSources of Information Gatheredto Assess Fraud Risksto Assess Fraud Risks

Communicationamong audit team

Inquiries ofmanagement

Riskfactors

Analyticalprocedures

Otherinformation

Identified risks of material misstatements due to fraud


Documenting Fraud Documenting Fraud AssessmentAssessment

Discussion

Specific risks

Procedures

Reasons

Nature of communications

Other conditions and analytical relationships


Corporate Governance OversightCorporate Governance Oversightto Reduce Fraud Risksto Reduce Fraud Risks

1. Culture of honesty and high ethics

2. Management's responsibilityto evaluate risks of fraud

3. Audit committee oversight


Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud

2003 1998 1994

Collusion betweenemployees and

third parties

Inadequateinternalcontrols

Managementoverride of

internal controls

483133

395859

313636


Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud

Collusion betweenemployees and

management

Lack of controlover management

by directors

Ineffective ornonexistent ethics orcompliance program

151923

1211 6

10 8 7

2003 1998 1994


Responding to the Risk of FraudResponding to the Risk of Fraud

Change the overall conduct of the auditto respond to identified fraud risks.

Design and perform audit proceduresto address identified risks.

Design and perform procedures toaddress the risk of managementoverride of controls.


Initial Detection Method for Million Dollar Initial Detection Method for Million Dollar SchemesSchemes

Tip

By Accident

Internal Audit

Internal Controls

External Audit

Notified By Police

$1,000,000+

All Cases

0% 10% 20% 30% 40% 50%

Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.

42.3%

46.2%

22.8%

20.0%

18.6%19.4%

16.7%23.3%

15.8%9.1%

6.0%3.2%

Typ

e of

Det

ectio

n


Specific Fraud Risk AreasSpecific Fraud Risk Areas

Inventory fraud risks

Revenue and accounts receivable fraud risks

Purchases and accounts payable fraud risks

Other areas of fraud risk


Responding to Misstatements That Responding to Misstatements That May Be the Result of FraudMay Be the Result of Fraud

When fraud is suspected, the auditor gathersadditional information to determine whetherfraud actually exists.

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens/Elder/Beasley Arens/Elder/Beasley 11 - 20

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©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 11 - 1 Fraud Auditing Chapter 11