Boynton SM Ch.09

CHAPTER 7

Chapter 9

Audit Risk, Including the Risk of Fraud

Learning Check

9-1. The KPMG 2003 Fraud Survey reported that 75% of organizations surveyed experienced some level of fraud in the last 12 months. Seven percent reported problems with fraudulent financial reporting and these had an average annual cost of over $250 million. The 2004 Report to the Nation of the Association of Certified Fraud Examiners included evidence on over 508 frauds that resulted in over $761 million in losses. The GAO report on financial statements restatements reported 919 financial statement restatements in a 5 year period. While all of these may not have been due to fraud, the incidence of fraud is not a matter of a few isolated instances. 9-2.Fraud is an intentional act that results in a material misstatement in financial statements that are the subject of an audit. Fraud is typically described as arising from two types of misstatements, fraudulent financial reporting and misappropriation of assets. Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements designed to deceive financial statement users where the effect causes the financial statements not to be presented, in all material respects, in conformity with generally accepted accounting principles (GAAP). Misstatements arising from misappropriation of assets (sometimes referred to as theft or defalcation) involve the theft of an entity's assets where the effect of the theft causes the financial statements not to be presented, in all material respects, in conformity with GAAP. Misappropriation of assets can be accomplished in various ways, including embezzling receipts, stealing assets, or causing an entity to pay for goods or services that have not been received.9-3. a.The three elements of the fraud triangle are incentives and pressures, opportunity, and attitudes and rationalization.b.An example of fraudulent financial reporting might include a situation where management feels significant pressure to meet earnings forecasts (whether analysts consensus forecasts or managements forecasts) and keep stock price high. Management is often in a position where it may override controls and so the opportunity may be present for management to ask individuals to record entries that might prematurely recognize revenue or to capitalize expenses. Management may also use their position to directly take actions to inaccurately record accounting information. Management may rationalize this behavior by believing that it is necessary to receive an adequate bonus, or management may push the envelop in accounting grey areas because the it is difficult for the auditor to prove that management is wrong. Management may also believe that the behavior is acceptable because other companies engage in similar activity. Revenue recognition problems relate to the existence and occurrence of sales and receivables. The capitalization of expenses relate to the presentation and disclosures (classification) of expenditures.c.An example of misappropriation of assets might represent a situation where a bookkeeper uses the opportunity to write check to him or her self. In this situation the incentive or pressure might be related to the need for funds to pay for private school or college for a child, or just to afford a lifestyle that the person would like to have. The opportunity would happen when the person has the authority to sign checks and internal controls are weak. This might include little management oversight of the accounting process (such as management directly receiving and reviewing bank statements before forwarding the statements to the bookkeeper). The bookkeeper might even record a disbursement in the accounting records using a different name than the check was actually written to. The individual might rationalize the activity by feeling that they are making up for a pay raise not received, or otherwise rationalize that they deserve the money. This misstatement is a problem with the existence and occurrence of cash disbursements.

9-4. Common risk assessment procedures used to assess the risk of fraud include: Making inquiries of management and other within the entity to obtain their views about the risk of fraud and how they are addressed.

Considering any unusual or unexpected relationships that have been identified in performing analytical procedures in audit planning.

Considering other information obtained while planning the audit, such as performing procedure to obtain the required understanding of internal controls.

Considering information obtained while performing procedures related to client acceptance and retention.9-5.The four objectives of the brainstorming session performed by the audit team to assess the risk of fraud are to:1. Allow junior members of the audit team to benefit from more senior members knowledge of the audit client and of how fraud might be perpetrated.

2. Allow more seasoned personnel a fresh set of eyes that might identify risks that otherwise might be overlooked.

3. Allows audit management to set the appropriate tone for the audit and to emphasize the importance of approaching the audit with a questioning mind.

4. Emphasize the possibility that fraud might exist in any audit.

9-6.Two specific risks that should be considered in every audit are:

1. The risk of problems with revenue recognition.

2. The risk of management override of internal controls.

In each case the auditor will usually assess inherent risk at the maximum for these risks, and then carefully study the system of internal controls that might mitigate these risks.The auditor might perform substantive tests targeted at testing revenue recognition or substantive tests that examine journal entries or other evidence of management override of internal controls.

9-7. The audit risk concept is particularly important because it provides a framework for (1) making decisions about the risk of financial statement misstatement(inherent and control risks), and (2) making decisions about the appropriate level of detection risk. For a specified level of audit risk there is an inverse relationship between assessed levels of inherent and control risks and the level of detection risk that an auditor can accept for an assertion. Thus, the lower the assessments of inherent and control risks, the higher the acceptable level of detection risk.

9-8. a.Inherent risk is the susceptibility of an assertion to a material misstatement, assuming that there are no related internal controls.

b.A pervasive inherent risk factor is one that will affect multiple account balances and assertions in the financial statements. For example, if management has incentives to use accounting techniques to boost earnings when it is unable to accomplish desired results with underlying economic substance, management may engage in aggressive revenue recognition policies or may attempt to capitalize items that might otherwise be expenses. Pervasive inherent risk factors ripple right through the financial statements. An assertion specific risk factor is one that only affects a unique assertion in the financial statements. For example, the client may have a contentious accounting issue, such as accounting for frequent flyer mileage liabilities for an airline, and the risk factor relates only to the valuation of the specific liability. 9-9. a. Control risk is the risk that a material misstatement could occur in an assertion and will not he prevented or detected on a timely basis by the entity's internal controls.

b.Control risk can never be zero because internal controls cannot provide complete assurance that all material misstatements will be prevented or detected.

c.To support an assessment of control risk below the maximum the auditor must obtain evidence about the effectiveness of the design and the operation of internal controls through (1) procedures to obtain an understanding of internal controls and (2) tests of controls.

9-10. a.Analytical procedures risk is the risk that the auditor will not detect a material misstatement that exists in an assertion through the application of analytical procedures.

b.The auditor determines the planned acceptable level of analytical procedures risk based for each assertion based on the expected effectiveness of analytical procedures performed. Chapter 8 explained that the effectiveness of analytical procedures is related to (Figure 8-5) the nature of the assertion, the plausibility and predictability of the relationship, the availability of reliable data, and the precision of the expectation.c.The auditor should not plan on designing effective analytical procures for significant inherent risks that preclude the performance of tests of details. The auditor should respond to these significant inherent risks by (1) assessing inherent risk as maximum or high for relevant assertions, (2) obtaining evidence about the effectiveness of design of internal controls related to the assertion, (3) ensuring that evidence about internal controls over significant inherent risks is obtained during the current audit period, and (4) obtaining significant evidence through tests of details of transactions and balances. Normally, audit evidence from substantive analytical procedures alone will provide sufficient, competent evidence related to and assertion with significant inherent risks.9-11. a.Tests of details risk is the risk that the auditor will not detect a material misstatement that exists in an assertion through the application of tests of details such as tests of transactions or tests of balances.

b.The auditor determines the planned acceptable level of tests of details risk based for each assertion based on the assessments of inherent risk, control risk, and analytical procedures risk. These three assessments affect audit strategy for tests of details. The planned levels of tests of details risk are subsequently revised based on evidence obtained about the effectiveness of internal controls or specific audit findings obtained while performing substantive tests including analytical procedures and tests of details.

9-12.For a specified level of audit risk, there is an inverse relationship between the assessed levels of inherent risk, control risk, and analytical procedures risk for an assertion and the level of detection risk for tests of details that the auditor can accept for that assertion.

9-13. The concept of reasonable assurance implies that the auditor will attempt to obtain the same level of assurance for each financial statement assertion. However, the assessed levels of inherent risk, control risks, and analytical procedures risk may vary of different assertions. Hence, the auditor intentionally varies the acceptable level of tests of details risk for each assertion and account to accomplish the desired level of overall audit risk.

9-14.No. It is not appropriate under GAAS for the auditor to conclude that inherent and control risks are so low that it is not necessary to perform any substantive tests for all of the assertions pertaining to an account. Some evidence must always be obtained from substantive tests (analytical procedures or tests of details) for each significant account balance, though not necessarily for each assertion related to the account. If the risk is a significant inherent risk the auditor should obtain evidence from substantive tests of details (analytical procedures alone normally will not provide sufficient, competent evidence).

9-15. The auditor can generally conclude that the following relationship exists between audit risk, materiality and audit evidence. If audit risk is held constant and the materiality level is reduced, the assurance obtained from substantive tests must increase, which would require more sufficient, competent evidence. Similarly, if we hold the materiality level constant and reduce audit risk, the assurance obtained during the audit must increase. In addition, the auditor can generally conclude that the following relationship exists between detection risk, materiality and substantive tests. If detection risk is held constant and the materiality level is reduced, the assurance obtained from substantive tests must increase. Similarly, if we hold the materiality level constant and reduce detection risk, the assurance obtained from substantive tests must increase.

9-16.The auditor's ultimate objective in planning and performing the audit is to reduce audit risk to an appropriately low level to support an opinion as to whether the financial statements are fairly presented in all material respects.

9-17. a.A preliminary audit strategy represents the auditor's preliminary judgments about an audit approach and is based on certain assumptions about the conduct of the audit. It is not a detailed specification of auditing procedures to be performed.

b. The four components of a preliminary audit strategy are:

1. The assessed level of inherent risk.

2. The planned assessed level of control risk considering:

The extent of understanding of internal controls to be obtained.

Tests of controls to be performed in assessing control risk.

3. The planned assessed level of analytical procedures risk considering:

The extent of the understanding of the business and industry to be obtained.

Analytical procedures to be performed that provide evidence about the fair presentation of an assertion.

4. The planned level of tests of details that, when combined with other procedures, reduces audit risk to an appropriately low level.

9-18. a.The three audit strategies are (1) a response to lower inherent risk, (2) a lower assessed level of control risk approach, and (3) a primarily substantive approach.b.A response to lower inherent risk is often effective for assertions where inherent risk can be assessed at moderate (or sometimes low) and analytical procedures are effective at identifying material misstatements. The costs of performing the more extensive procedures to obtain an understanding of the business and industry and to perform reliable analytical procedures will often be more than offset by cost savings from performing minimal tests of details.

The lower assessed level of control risk approach offers the potential for cost savings when used for assertions pertaining to accounts affected by a high volume of transactions. When controls related to such assertions are well designed and highly effective, the cost of performing the more extensive procedures to obtain the understanding of internal controls and to test the controls will often be more than offset by cost savings from performing less extensive tests of details.

The primarily substantive approach may be more cost effective for assertions pertaining to accounts that are affected by infrequent transactions or adjusting entries. In addition, if inherent risk is high or maximum, and internal controls are ineffective, a primarily substantive approach is the only way to restrict audit risk to an appropriately low level.

9-19.The rationale for using a common strategy for a group of assertions affected by the same class of transactions is that many internal controls focus on the processing of a single type or class of transactions. Accordingly, the effectiveness of controls related to that class of transactions will affect control risk for the assertions related to the transaction class. For example, the effectiveness of controls related to the existence or occurrence of sales transactions affects control risk for existence or occurrence account balance assertions for both sales and accounts receivable.Comprehensive Questions

9-20.(Estimated time - 25 minutes)

The following table identifies the fraud risk factors as related to fraudulent financial reporting (FFR) or misappropriation of assets (MA), and whether they are indicators of incentive and pressures (I/P), opportunity (O), or rationalization (R).

FFR or MAI/P, O, or R

1. Personal financial obligations may create pressure on management or employees with access to cash or other assets susceptible to theft to misappropriate those assets.MAI/P

2. A company has significant, unusual, or highly complex transactions, especially those close to period end that pose difficult "substance over form" questions.FFRO

3. A company experiences rapid growth or unusual profitability, especially compared to that of other companies in the same industry.FFRO

4. A company has inadequate system of authorization and approval of transactions (for example, in purchasing).FFR or MAO

5. Employees show disregard for the need for monitoring or reducing risks related to misappropriations of assets.MAR

6. Personal financial obligations may create pressure on management or employees with access to cash or other assets susceptible to theft to misappropriate those assets.MAI/P

7. There is excessive pressure on management or operating personnel to meet financial targets set up by the board of directors or management, including sales or profitability incentive goals.FFRI/P

8. Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate.FFRO

9. Nonfinancial management shows an excessive participation in or preoccupation with the selection of accounting principles or the determination of significant estimates.FFRO

10. Management shows a domineering behavior in dealing with the auditor, especially involving attempts to influence the scope of the auditor's work or the selection or continuance of personnel assigned to or consulted on the audit engagement.FFRI/P

11. Employees anticipate future layoffs.MAI/P

12. An employees behavior indicates displeasure or dissatisfaction with the company or its treatment of the employee.MAI/P

13. A company has significant related-party transactions not in the ordinary course of business or with related entities not audited or audited by another firm.FFRO

9-21.(Estimated Time 25 minutes)

Following is a discussion of the various fraud risk factors identified in the case, including an explanation of assertions that might be affected by the risk factors.

(a) Fraud Risk Factor(b) Affect on Financial Statement Assertions

The company competes in the highly competitive market for manufactured household products. This is combined with the fact that the company has performed well up until a recent recession, but now the company is having difficulty moving inventory in most product lines as retailers have difficult selling in a down economy.This combination of competitive markets and a downturn in the economy create the incentives and pressures for fraudulent financial reporting and it may have a pervasive affect on multiple account balances or financial statement assertions.

The company is dominated by Rob Bigbucks, the Chairman and Chief Executive Officer that has guided the company since it was a private company and has extensive influence all aspects of company operations. Rob is known to have a short temper and have been known to threaten individuals in the accounting department with the lack of pay raises if they dont assist him in achieving company goals.Robs threats create the incentives and pressures for fraudulent financial reporting. This is likely to have a pervasive impact on the financial statements given that multiple individuals in the accounting department feel threatened. Hence, multiple accounts or assertions may be misstated.

The company has extended its influence over customers and has dictated terms of sale to ensure that customers are able to obtain desired quantities of their most popular products.The influence over customers is likely to create the opportunity for revenue recognition issues. The most likely assertion that might be misstated is the existence and occurrence assertion for sales and receivables.

Bonuses based on sales are a significant component of the compensation package for individual product sales managers.Bonuses based on sales targets create the incentive for fraudulent financial reporting, and premature revenue recognition, in order for sales managers to earn bonuses. The most likely assertion that might be misstated is the existence and occurrence assertion for sales and receivables.

Sales managers who do not meet sales targets three quarters in a row are often replaced.In order to keep their jobs, sales managers may engage in fraudulent financial reporting and premature revenue recognition. The most likely assertion that might be misstated is the existence and occurrence assertion for sales and receivables.

9-22. (Estimated Time 25 minutes)

The following table presents the solutions to parts a and b.

c.Situations C and G mean that the evidence obtained from risk assessment procedures, tests of controls, and analytical procedures may reduce audit risk to an appropriately low level.

d.Situation E represents a situation with maximum inherent risk. In other words this is a significant inherent risk. The proposed audit strategy emphasizes analytical procedures and minimizes tests of details. It is not appropriate to place such a significant emphasis on analytical procedures for assertions that represent significant inherent risks.

e.Assuming that inherent risk is assessed at the maximum, two important audit strategies are (1) a lower assessed level of control risk approach, and (2) a primarily substantive approach emphasizing tests of details. Under a lower assessed level of control risk approach an increased understanding of internal controls to allow for the effective design of tests of controls. Under a primarily substantive approach emphasizing tests of details the auditor needs a sufficient understanding of the system of internal control to effectively design substantive tests.


a & b.The following matrix summarizes the planned assessed levels of tests of details risk and planned audit evidence. In addition, it ranks the cases in rank order indicated the scenarios that would require the most extensive tests of details (1) to the least extensive tests of details (5).

Situation

ABCDE

Desired audit riskVery LowVery LowVery LowVery LowVery Low

Assessed inherent riskMaximumHighModerateLowMaximum

Planned assessed level of control riskLowHighHighModerateHigh

Planned assessed level of analytical procedures riskModerateModerateLowLowHigh

Planned assessed level of test of details riskHighLowHighHighVery Low

Planned evidenceSee belowSee belowSee belowSee belowSee below

Ranking of Evidence from Tests of Details42351

The planned evidence for situation A requires significant tests of controls and very effective analytical procedures. As a results it requires a minimal amount of substantive tests of details.The planned evidence in situation B requires some evidence from risk assessment procedures regarding inherent risk, control risk is likely to be assessed based on procedures performed to obtain an understanding of internal controls, and the auditor performs some analytical procedures and significant tests of details.

The planned evidence in situation C requires compelling evidence from risk assessment procedures to support an inherent risk assessment of moderate, control risk is likely to be assessed based on procedures performed to obtain an understanding of internal controls, the auditor performs very effective analytical procedures and limited tests of details.

The planned evidence in situation D requires compelling evidence from risk assessment procedures to support an inherent risk assessment of low (e.g., prepaid expenses), control risk is likely to be assessed based on procedures performed to obtain an understanding of internal controls and tests of controls to support a moderate assessment of control risk, and the auditor performs very effective analytical procedures.

The planned evidence in situation E would probably be supported by a control risk assessment based on procedures performed to obtain an understanding of internal controls, some analytical procedures and very reliable tests of details.

b. Substantive tests of details may not be necessary in situation D. To start with inherent risk for this assertion is low. Further, significant evidence is obtained from analytical procedures and the auditor has some evidence that internal controls are effective. This combination is sufficient that the auditor may not need additional detail tests.


a.

Item with HigherInherent RiskExplanation

1.aInventories generally involve a higher volume of transactions and are more susceptible to theft.

2.bAccounting standards for the valuation of deferred income taxes are more complex and contentious than those for cash.

3.bAccounts payable is more likely to be deliberately understated than overstated.

4.bObligations under warranties may be more difficult to estimate than obligations for accrued wages.

5.aThe classification of an item as repairs and maintenance versus a capital expenditure may be contentious.

6.aAccounting standards for the valuation of long-term investments are more complex (fair value, equitymethod, etc.) than for land which is carried at itshistorical cost.

7.aAccounts receivable is more likely to be deliberately overstated than understated.

8.aCash is more susceptible to misappropriation butexisting cash is simply reported at face amount.

9.aEstimates of bad debts expense may vary from year toyear and may be more difficult to make than theestimates involved in calculating depreciation.

10.aThe valuation of a transaction resulting in a receivable from a related party may not be as objective as the valuation of a transaction with a third party.

b.Examples of matters that may have pervasive effects on inherent risk include the following

(Note - students are required to state only five):

Profitability of the entity relative to the industry.

Sensitivity of operating results to economic factors.

Going concern problems such as lack of sufficient working capital.

Nature, cause, and amount of known and likely misstatements detected in prior audit.

Management turnover, reputation, and accounting skills.

The impact of technological developments on the company's operations and competitiveness.

9-25. (Estimated Time 20 minutes)Inherent Risk FactorPervasive Effect(yes/ no)Accounts AffectedAssertions Affected

1. The original CFO for a company in the entertainment industry just retired and a new CFO, with modest industry experience, was hired from a CPA firm.YesMultipleMultiple

2. During the last year the companys most profitable product has experienced significant competition and inventory quantities are building.NoInventory and Cost of Goods SoldValuation and Allocation (Net Realizable Value)

3. A software company has recently changed its product and is now selling both a site license bundled with consulting services to tailor the software to the clients needs.NoSales and Accounts ReceivableExistence and Occurrence (Revenue Recognition)

4. Financial difficulties during a recent economic slowdown have put the company in a position where it is close to violation of debt covenants.YesMultipleMultiple

5. A larger diversified retailer has just made a decision to put a high-end jewelry line in its stores.NoInventory and Cost of Goods SoldExistence and Occurrence

6. A pharmaceutical company recently invested $500 million in research and development over the last five years in a product that failed to receive FDA approval.NoAny Capitalized Research and Development CostValuation and Allocation (Impairment Test)


The risk component that is directly affected by each factor is:

1. = TD6. = TD

2. = CR7. = IR

3. = IR8. = CR

4. = AP9. = TD

5. = IR10. = IR

9-27.(Estimated Time 25 minutes)a. A preliminary audit strategy represents the auditors preliminary judgments about an audit approach and is based on certain assumptions about the conduct of the audit. It represent an audit plan for the collection of evidence regarding an assertion.

b. In developing a preliminary audit strategy the auditor needs to specify (1) inherent risk, (2) the planned assessed level of control risk, and (3) the planned assessed level of analytical procedures risk. These represent three key components of the audit risk model.

c. Assuming that inherent risk is assessed at the maximum, two important audit strategies are (1) a primarily substantive approach and (2) a lower assessed level of control risk approach. Under a primarily substantive approach the auditor needs a sufficient understanding of the system of internal control to effectively design substantive tests. Under a lower assessed level of control risk approach an increased understanding of internal controls to allow for the effective design of tests of controls.

d. A primarily substantive approach would be favored when internal controls are not present or are not effective. This approach would also be favored for material populations that have few transactions or balances that can easily be tested (e.g., notes payable). A lower assessed level of control risk approach would be favored when controls related to an assertion are well designed and highly effective, and the populations includes a high volume of routine transactions (which makes this approach cost effective).


Preliminary Audit Strategy

1.A lower assessed level of control risk approach

2.A primarily substantive approach









Cases

9-29.See separate file with answers to the comprehensive case related to the audit of Mt. Hood Furniture that is included with this chapter.

Professional Simulation

Research

SituationProfessional SkepticismFraud Risk

Three citations might be relevant here.

First, AU 316.07

Three conditions generally are present when fraud occurs. First, management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. Second, circumstances existfor example, the absence of controls, ineffective controls, or the ability of management to override controlsthat provide an opportunity for a fraud to be perpetrated. Third, those involved are able to rationalize committing a fraudulent act. Some individuals possess an attitude, character, or set of ethical values that allow them to knowingly and intentionally commit a dishonest act. However, even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them. The greater the incentive or pressure, the more likely an individual will be able to rationalize the acceptability of committing fraud.

It is important to note that honest individuals can commit fraud in an environment that imposes sufficient pressure on them.

Second, AU 316.13

Due professional care requires the auditor to exercise professional skepticism. See section 230, Due Professional Care in the Performance of Work, paragraphs .07 through .09. Because of the characteristics of fraud, the auditor's exercise of professional skepticism is important when considering the risk of material misstatement due to fraud. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. The auditor should conduct the engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the entity and regardless of the auditor's belief about management's honesty and integrity. Furthermore, professional skepticism requires an ongoing questioning of whether the information and evidence obtained suggests that a material misstatement due to fraud has occurred. In exercising professional skepticism in gathering and evaluating evidence, the auditor should not be satisfied with less-than-persuasive evidence because of a belief that management is honest.This paragraph is clear that the auditor should conduct the engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the entity and regardless of the auditor's belief about management's honesty and integrity. Third, AU 316.15,

The discussion among the audit team members about the susceptibility of the entity's financial statements to material misstatement due to fraud should include a consideration of the known external and internal factors affecting the entity that might (a) create incentives/pressures for management and others to commit fraud, (b) provide the opportunity for fraud to be perpetrated, and (c) indicate a culture or environment that enables management to rationalize committing fraud. The discussion should occur with an attitude that includes a questioning mind as described in paragraph .16 and, for this purpose, setting aside any prior beliefs the audit team members may have that management is honest and has integrity. In this regard, the discussion should include a consideration of the risk of management override of controls. Finally, the discussion should include how the auditor might respond to the susceptibility of the entity's financial statements to material misstatement due to fraud.

This paragraph is clear that the auditor should put aside any prior beliefs the audit team members may have that management is honest and has integrity, during the brainstorming session.

Professional Skepticism

SituationResearchFraud Risk

To: Audit Team

Re: Professional Skepticism

From:CPA Candidate

The professional standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence. (AU 230.07) The auditor should gather and objectively evaluate evidence. Since evidence is gathered and evaluated throughout the audit, professional skepticism should be exercised throughout the audit process. Further, the standards go on to state that the auditor neither assumes that management is dishonest nor assumes unquestioned honesty. In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest. (AU 230.09)Professional standards on the brainstorming point out that the discussion among the audit team members should emphasize the need to maintain a questioning mind and to exercise professional skepticism in gathering and evaluating evidence throughout the audit. Even if detection risk is high, this should lead the audit team members to continually be alert for information or other conditions that indicate a material misstatement due to fraud may have occurred. Professional standards are clear that lead audit team members to thoroughly probe the issues, acquire additional evidence as necessary, and consult with other team members and, if appropriate, experts in the firm, rather than rationalize or dismiss information or other conditions that indicate a material misstatement due to fraud may have occurred. (AU 316.16)Fraud Risk

SituationResearchProfessional Skepticism

Following is list of various fraud risks. Identify whether the following situations represent incentives / pressures, opportunity, or attitudes / rationalizations. This solution is based on Appendix A to AU 316. Incentive / PressureOpportunityAttitude / Rationalization

1. Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate(((

2. Excessive interest by management in maintaining or increasing the entity's stock price or earnings trend(((

3. Lack of complete and timely reconciliations of assets(((

4. High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates(((

5. Adverse relationships between the entity and employees with access to cash or other assets susceptible to theft(((

6. Behavior indicating displeasure or dissatisfaction with the company or its treatment of the employee(((

7. Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult "substance over form" questions(((

8. A practice by management of committing to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts(((

_1184008111.xlsSheet1

ABCDEFG

Desired audit risk1%1%5%5%5%5%10%

Assessed inherent risk20%50%20%100%100%50%50%

Planned assessed level of control risk50%50%80%10%80%25%25%

Planned assessed level of analytical procedure risk50%50%25%75%15%50%50%

Planned assessed level of test of details risk20.00%8.00%Maximum66.67%41.67%80.00%Maximum

Ranking (1) = the most evidence from substantive

tests of details.21**435**

** Substantive tests of details may not be required

Documents

Boynton SM Ch.09