Presentation on theme: "Evolution of the Fraud Standard from AUS 210 to ASA 240"— Presentation transcript:
1 Evolution of the Fraud Standard from AUS 210 to ASA 240 Chartered Accountants Audit ConferenceEvolution of the Fraud Standard from AUS 210 to ASA 240Marj Wessels CADirector Professional StandardsPKFcharteredaccountants.com.au
3 ObjectivesProvide background against which the current fraud standard has developedExamine the revised fraud standard issued shortly after the Enron bankruptcy filingExamine the fraud standard updated by the IAASB in conjunction with the risk standards, and adopted by the AUASB 15 December 2004Consider the mandatory requirements of the current legislated fraud standard
4 The US Sneezes the World catches Cold Heading StyleThe Enron DebacleBody copy> Bullet styleThe US Sneezes the World catches Cold
5 Protection of Investors and the Public Pre - Enron USAustraliaGAAP – Generally Accepted Accounting Principles GAAS – Generally Accepted Auditing Standards SAS – Statements on Auditing Standards & All Professional EthicsAASBAUSAGS and APS
6 The Accounting Theory GAAP defined as: a dynamic set of both broad and specific guidelinesthat companies should followwhen measuring and reportingFinancial information
7 The Old Auditing Theory During annual audits performed by externalindependent auditors checks were performed tomake sure:The entity following GAAP consistentlyIf not, entity to show rationale why notEntity required to demonstrate treatment is ethical and appropriate in their specific situation
8 The Old Auditing Theory Cont’d This left the field open to interpretationAICPA added stipulation of consistent application over time.Aim of GAAP & AICPA rules to makefinancial statements as accurate and reliable as possible
9 What Did Enron Do? Took existing rules and circumvented them Balance sheet bolstered by inflated asset valuesDispersed liabilities to subsidiariesFailed to consolidate these subsidiariesMassive misstatement of financial statementsDesigned so that certain individuals in the company could make money from increased investments by shareholders
10 Enron’s GAAP Strategy Balance sheet with many intellectual assets Patents and trademarks were goodActual assets were bad & should be immaterial compared to intangiblesMost of the debts and tangible assets on balance sheets of partnerships run by key officers of the entity.
11 The Outcome of Enron’s Activities When Enron declared bankruptcy on December 2001 it had$US 13.1 billion in debt on Enron’s books$US 18.1 billion in debt on subsidiaries booksEstimated $US 20 billion more debt off balance sheet (Zellner)
12 Perceived Failings of the Auditors AA Perception about their independenceEnron 2nd largest AA clientConsulting fees earned in 2000 more than half total fees earnedDid not identify fraud where fraud existedInternal memos evidenced unresolved conflict between auditors and audit committee
13 Perceived Failings of the Auditors AA Internal AA s expressing concern about Enron’s accounting practicesConcerns overturned by the Lead PartnerSuspicion/ evidence that the Audit Team wrote fraudulent memos stating that the Professional Standards Group approved of the accounting practices.
14 Perceived Failings of the Auditors AA AA had 2 major recent audit failures beforeEnron:1996 Waste ManagementIncome inflated by over $ 1billion between 1992 and 19961997 Sunbeam –SEC determined – Sunbeam used Accounting tricks tocreate false sales and profit.
15 AICPA Response SAS Standards Effective Impact Example SAS 96 January 2002Dealt with record retention policies and requirement for auditor to document all significant decisions or judgementsApproval by auditor of client application of GAAPSAS 98Made many revisions and amendments to previous statementsChanges to GAASRelationship between GAAS & Quality Control StandardsAudit risk and materiality concepts in auditsSAS 99Outlines what fraud is and reaffirms necessity to gather all informationRevenue Recognition recognised as a fraud risk
16 Ongoing update and refinement of the existing Fraud Standard Heading StyleAUASB ResponseBody copy> Bullet styleOngoing update and refinement of the existing Fraud Standard
17 ASA 240 Legislated & effective 1 July 2006 ContentAUS 210 Issued January 2002AUS 210 Issued June 2004ASA 240 Legislated & effective 1 July 2006
18 Heading StyleAUS Issued January 2002Body copy> Bullet styleAuditor’s responsibility to consider Fraud and Error In an Audit of a Financial Report
19 AUS 210 – Issued January 2002“Auditors responsibility to consider Fraud and Error In an Audit of a Financial Report”Effective 15 December 2002Compatible with ISA 250Replaced AUS 210 –”Irregularities, Including Fraud , Other Illegal Acts and Errors” – October 1995 revised February 1999
20 AUS 210 – Issued January 2002Focuses on auditor’s responsibilities with respect to fraud and errorExplains the distinction between fraud and errorPrimary responsibility for prevention and detection noted to rest with both:Those charged with governance andManagement
21 AUS 210 – Issued January 2002AUS 218 “Consideration of Laws and Regulations in an Audit of a Financial Report” issued to address Laws and Regulations separatelyAUS 210 ( 2002), focuses on Fraud and Error onlyExpanded the basic principles and essential proceduresRelating to risk of material misstatement resulting from fraud and errorIn an audit of a financial report
22 AUS 210 – Issued January 2002 Introduced requirement for: Auditor Discussions with Audit Team at planning stageMore extensive enquiries of management with respect to fraud & errorFraud & error considerations to be linked to assessment of inherent and control risk, and vice versa.Design of audit procedures to specifically respond to and address identified risk of fraud & to be documentedConsideration whether any misstatement identified indicates fraud
23 AUS 210 – Issued January 2002Management Representation Letters to include:Disclosure of all facts relating to fraud or possible fraudManagements belief that the uncorrected misstatementsaggregated by the auditor are immaterial to the financial statements as a whole
24 AUS 210 – Issued January 2002Communication by the auditor to the appropriate levelof management or Governance:Specific matters in relation to fraud or errorIncluding material misstatements due to errorTimely communication requiredCommunication to those charged with governance of uncorrected misstatements aggregated by the auditor and determined by management to be immaterial both:Individually and inAggregate
25 AUS 210 – Issued January 2002 Emphasised the distinction between Management FraudEmployee fraudExpanded the discussion of fraudulent financial reportingClarified the discussion of the inherent limitations of an audit to detect fraud
26 AUS 210 – Issued January 2002Emphasised the importance of professional scepticismAlert to evidence that brings into question reliability of management representationsRisk of over generalising when drawing conclusions from audit observationsRisk of using faulty assumptions in determining audit procedures and evaluating results
27 Distinction Between Fraud and Error Misstatements in the financial report canarise from fraud or error:Fraud – underlying action intentionalError – underlying action unintentional
28 Definition of Error Under AUS 210 A mistake in gathering or processing data from which the financial report is prepared.An incorrect accounting estimate arising from oversight or misinterpretation of facts.A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation or disclosure.
29 Fraud for Purposes of AUS 210 Causes a material misstatement in the financial reportIntentional Act by management, those charged with governance, employees, or third partiesInvolves the use of deception to obtain an unjust or illegal advantage.
30 Types of Fraud AUS 210 2 Types of fraud that are relevant to auditors: Fraudulent financial reportingMisappropriation of assets
31 Fraudulent Financial Reporting Can be accomplished by: Manipulation, falsification (including forgery), or alteration of accounting records or supporting documentation from which the financial report is preparedMisrepresentation, or intentional omission from the financial report of events, transactions and other significant informationIntentional misapplication of accounting principle relating to amounts, classifications, manner of presentation, or disclosures
32 Management Override Examples include: Concealing or not disclosing facts that may affect amounts in the financial reportEngaging in complex transactions that are structured to misrepresent financial position or performance of the entityAltering records or terms related to significant and unusual transactions
33 Misappropriation of Assets Involves theft of an entity’[s assets and is often perpetrated by employees in relatively small and immaterial amounts and is usually accompanied by false or misleading documentation to cover up the fact that assets are missing or have been pledged. Examples:Embezzling receiptsStealing physical assetsCausing an entity to pay for goods and services not receivedUsing an entity’s assets for personal use
34 What Does Fraud Involve Incentive or pressure to commit the fraudPerceived opportunity to commit the fraudRationalisation of the act
35 AUS 210- Issued June 2004The Auditors Responsibility to Consider Fraud in an Audit of a Financial Report
36 AUS 210 – Issued June 2004 Effective 15 December 2004 Built on the new Risk Standards issued in 2003Requires the auditor to:Be more proactive in considering the risk of fraud in an audit of a financial reportFocus on areas where there is a risk of material misstatement due to fraudPay attention to the risk of management fraudDesign and perform procedures to respond to identified risks
37 AUS 210 – Issued June 2004 Requires the auditor to: Perform procedure to obtain information that is used to identify the risks of material misstatementIdentify risks at assertion level and at financial report levelEvaluate controls related to material identified riskDetermine responses to identified risk of fraudEstablishes documentation requirements
38 AUS 210 – Issued June 2004Based on revised ISA 240 issued by the IAASB in early 2004.
39 ASA 240 Issued April 2006 The Auditors Responsibility to Heading StyleBody copy> Bullet styleThe Auditors Responsibility toConsider Fraud in an Audit of aFinancial Report - Legislated
40 ASA 240 – Issued April 2006Effective as a legislated standard 1 July 2006Use of word ‘ shall’ instead of ‘should” in mandatory paragraphsClarity on impact of guidance paragraphsNeed to consider implications of Whistle blowing legislation
41 Mandatory ( Bold letter) Requirements of ASA 240 Consider the risks of material misstatement in the financial report due to fraudExercise professional scepticismHold engagement team discussions on risk of fraudCommunications on fraud to other team members not involved in the team discussionMake enquiries of management & others on existence of fraud and risk of fraud
42 Mandatory (Bold letter) Requirements of ASA 240 Enquiries of those charged with Governance on existence & risk of fraudConsideration of fraud risk factorsPerforming analytical reviewObtaining and understanding internal controlIdentifying significant risks of fraud at the assertion level and financial report levelTreat Revenue recognition as a presumed significant risk of fraud.
43 Mandatory (Bold letter) Requirements of ASA 240 In determine overall response to address the risks of material misstatement due to fraud at the financial report level:Consider assignment and supervision of personnelConsider accounting polices usedIncorporate an element of unpredictability
44 Mandatory (Bold letter) Requirements of ASA 240 To respond to management override of control:Test appropriateness of journal entriesReview accounting estimates for biasesUnderstand business rationale of significant or unusual transactions
45 Mandatory (Bold letter) Requirements of ASA 240 Perform overall analytical review at or near the end of the auditConsider whether misstatements identified are indicative of fraudRequirement to consider implication for the audit where fraud exists and financial report may as a result be materially misstated
46 Mandatory (Bold letter) Requirements of ASA 240 Management representation letters obtainedby the auditor to include acknowledgement bymanagementResponsibility for design an implementation of internal control to prevent and detect fraudDisclosure of results of its assessment of risk that financial report may be misstated due to fraudDisclosure of management, employee or other fraud
47 Mandatory (Bold letter) Requirements of ASA 240 Communication by the auditor of existence of identified fraud to those charged with Governance as soon as practical
48 Mandatory (Bold letter) Requirements of ASA 240 Considerations if auditor is unable to continue with the engagement due to fraud
49 Mandatory (Bold letter) Requirements of ASA 240 DocumentationFraud discussions of audit TeamIdentified fraud risks at the assertion level and the financial report levelOverall responses to assessed risks of material misstatement due to fraud at the financial report levelLinkage of those procedures with assertion level riskResults of those the audit procedures
50 Mandatory (Bold letter) Requirements of ASA 240 The auditor is required to document:Fraud communications to management, those charge withgovernance, regulators and othersIf justified, effective rebuttal of the presumption thatrevenue recognition is a significant risk of fraud
51 Summary Activities Under ASA 240 PlanningMap Planning to Risk of material misstatement and plan audit responseRespond toManagementOverrideCompletion * Reporting on fraudTeam Fraud DiscussionsRisk of misstatement at the Financial ReportLevelRisk of misstatement at the Assertion LevelRevenue RecognitionJE testingReview Accounting Estimates for BiasUnderstand business rationaleManagement rep lettersOverall Analytical reviewReport to managementReport to TCWGReport to regulatory bodiesDiscussions with management & TCWGPreliminary Analytical reviewObtainunderstanding of the entityObtain understanding of internal control
52 Conclusion Discussion Enquiry Professional Scepticism Understanding risk of fraudRevenue Recognition mandatory significant risk of fraudAuditor responseConsider Management OverrideDocumentationCommunication & Reporting