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Chartered Accountants Audit Conference charteredaccountants.com.au Evolution of the Fraud Standard from AUS 210 to ASA 240 Marj Wessels CA Director Professional.

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Presentation on theme: "Chartered Accountants Audit Conference charteredaccountants.com.au Evolution of the Fraud Standard from AUS 210 to ASA 240 Marj Wessels CA Director Professional."— Presentation transcript:

1 Chartered Accountants Audit Conference charteredaccountants.com.au Evolution of the Fraud Standard from AUS 210 to ASA 240 Marj Wessels CA Director Professional Standards PKF

2 Content Objectives The Enron debacle AICPA Response AUASB Response Conclusion

3 Objectives > Provide background against which the current fraud standard has developed > Examine the revised fraud standard issued shortly after the Enron bankruptcy filing > Examine the fraud standard updated by the IAASB in conjunction with the risk standards, and adopted by the AUASB 15 December 2004 > Consider the mandatory requirements of the current legislated fraud standard

4 Heading Style Body copy > Bullet style The Enron Debacle The US Sneezes the World catches Cold

5 Protection of Investors and the Public Pre - Enron US GAAP – Generally Accepted Accounting Principles GAAS – Generally Accepted Auditing Standards SAS – Statements on Auditing Standards & All Professional Ethics Australia AASB AUS AGS and APS

6 The Accounting Theory GAAP defined as: > a dynamic set of both broad and specific guidelines > that companies should follow > when measuring and reporting > Financial information

7 The Old Auditing Theory During annual audits performed by external independent auditors checks were performed to make sure: > The entity following GAAP consistently > If not, entity to show rationale why not > Entity 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 interpretation > AICPA added stipulation of consistent application over time. > Aim of GAAP & AICPA rules to make > financial statements as accurate and reliable as possible

9 What Did Enron Do? > Took existing rules and circumvented them > Balance sheet bolstered by inflated asset values > Dispersed liabilities to subsidiaries > Failed to consolidate these subsidiaries > Massive misstatement of financial statements > Designed 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 good > Actual assets were bad & should be immaterial compared to intangibles > Most 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 books > Estimated $US 20 billion more debt off balance sheet (Zellner)

12 Perceived Failings of the Auditors AA > Perception about their independence Enron 2 nd largest AA client Consulting fees earned in 2000 more than half total fees earned > Did not identify fraud where fraud existed > Internal memos evidenced unresolved conflict between auditors and audit committee

13 Perceived Failings of the Auditors AA > Internal AA emails expressing concern about Enron’s accounting practices > Concerns overturned by the Lead Partner > Suspicion/ 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 before Enron: > 1996 Waste Management Income inflated by over $ 1billion between 1992 and 1996 > 1997 Sunbeam – SEC determined – Sunbeam used Accounting tricks to create false sales and profit.

15 AICPA Response SAS Standards EffectiveImpactExample SAS 96January 2002Dealt with record retention policies and requirement for auditor to document all significant decisions or judgements Approval by auditor of client application of GAAP SAS 98Made many revisions and amendments to previous statements Changes to GAASRelationship between GAAS & Quality Control Standards Audit risk and materiality concepts in audits SAS 99Outlines what fraud is and reaffirms necessity to gather all information Revenue Recognition recognised as a fraud risk

16 Heading Style Body copy > Bullet style AUASB Response Ongoing update and refinement of the existing Fraud Standard

17 Content AUS 210 Issued January 2002 AUS 210 Issued June 2004 ASA 240 Legislated & effective 1 July 2006

18 Heading Style Body copy > Bullet style AUS 210- Issued January 2002 Auditor’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 2002 > Compatible with ISA 250 > Replaced AUS 210 –”Irregularities, Including Fraud, Other Illegal Acts and Errors” – October 1995 revised February 1999

20 AUS 210 – Issued January 2002 > Focuses on auditor’s responsibilities with respect to fraud and error > Explains the distinction between fraud and error > Primary responsibility for prevention and detection noted to rest with both: Those charged with governance and Management

21 AUS 210 – Issued January 2002 > AUS 218 “Consideration of Laws and Regulations in an Audit of a Financial Report” issued to address Laws and Regulations separately > AUS 210 ( 2002), focuses on Fraud and Error only Expanded the basic principles and essential procedures Relating to risk of material misstatement resulting from fraud and error In an audit of a financial report

22 AUS 210 – Issued January 2002 Introduced requirement for: > Auditor Discussions with Audit Team at planning stage > More extensive enquiries of management with respect to fraud & error > Fraud & 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 documented > Consideration whether any misstatement identified indicates fraud

23 AUS 210 – Issued January 2002 Management Representation Letters to include: > Disclosure of all facts relating to fraud or possible fraud > Managements belief that the uncorrected misstatements > aggregated by the auditor are immaterial to the financial statements as a whole

24 AUS 210 – Issued January 2002 Communication by the auditor to the appropriate level of management or Governance: > Specific matters in relation to fraud or error > Including material misstatements due to error > Timely communication required > Communication to those charged with governance of uncorrected misstatements aggregated by the auditor and determined by management to be immaterial both: Individually and in Aggregate

25 AUS 210 – Issued January 2002 > Emphasised the distinction between Management Fraud Employee fraud > Expanded the discussion of fraudulent financial reporting > Clarified the discussion of the inherent limitations of an audit to detect fraud

26 AUS 210 – Issued January 2002 > Emphasised the importance of professional scepticism > Alert to evidence that brings into question reliability of management representations > Risk of over generalising when drawing conclusions from audit observations > Risk of using faulty assumptions in determining audit procedures and evaluating results

27 Distinction Between Fraud and Error Misstatements in the financial report can arise from fraud or error: > Fraud – underlying action intentional > Error – 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 report > Intentional Act by management, those charged with governance, employees, or third parties > Involves 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 reporting > Misappropriation 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 prepared > Misrepresentation, or intentional omission from the financial report of events, transactions and other significant information > Intentional 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 report Engaging in complex transactions that are structured to misrepresent financial position or performance of the entity Altering 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 receipts Stealing physical assets Causing an entity to pay for goods and services not received Using an entity’s assets for personal use

34 What Does Fraud Involve > Incentive or pressure to commit the fraud > Perceived opportunity to commit the fraud > Rationalisation of the act

35 AUS 210- Issued June 2004 The 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 2003 > Requires the auditor to : Be more proactive in considering the risk of fraud in an audit of a financial report Focus on areas where there is a risk of material misstatement due to fraud Pay attention to the risk of management fraud Design 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 misstatement > Identify risks at assertion level and at financial report level > Evaluate controls related to material identified risk > Determine responses to identified risk of fraud > Establishes documentation requirements

38 AUS 210 – Issued June 2004 > Based on revised ISA 240 issued by the IAASB in early 2004.

39 Heading Style Body copy > Bullet style ASA 240 Issued April 2006 The Auditors Responsibility to Consider Fraud in an Audit of a Financial Report - Legislated

40 ASA 240 – Issued April 2006 > Effective as a legislated standard 1 July 2006 > Use of word ‘ shall’ instead of ‘should” in mandatory paragraphs > Clarity on impact of guidance paragraphs > Need 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 fraud > Exercise professional scepticism > Hold engagement team discussions on risk of fraud > Communications on fraud to other team members not involved in the team discussion > Make 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 fraud > Consideration of fraud risk factors > Performing analytical review > Obtaining and understanding internal control > Identifying significant risks of fraud at the assertion level and financial report level > Treat 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 personnel > Consider accounting polices used > Incorporate an element of unpredictability

44 Mandatory (Bold letter) Requirements of ASA 240 To respond to management override of control : > Test appropriateness of journal entries > Review accounting estimates for biases > Understand 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 audit > Consider whether misstatements identified are indicative of fraud > Requirement 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 obtained by the auditor to include acknowledgement by management > Responsibility for design an implementation of internal control to prevent and detect fraud > Disclosure of results of its assessment of risk that financial report may be misstated due to fraud > Disclosure 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 Documentation > Fraud discussions of audit Team > Identified fraud risks at the assertion level and the financial report level > Overall responses to assessed risks of material misstatement due to fraud at the financial report level > Linkage of those procedures with assertion level risk > Results 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 with > governance, regulators and others > If justified, effective rebuttal of the presumption that > revenue recognition is a significant risk of fraud

51 Summary Activities Under ASA 240 Planning Map Planning to Risk of material misstatement and plan audit response Respond to Management Override Completion * Reporting on fraud Team Fraud Discussions Risk of misstatement at the Financial Report Level Risk of misstatement at the Assertion Level Revenue Recognition JE testing Review Accounting Estimates for Bias Understand business rationale Management rep letters Overall Analytical review Report to management Report to TCWG Report to regulatory bodies Discussions with management & TCWG Preliminary Analytical review Obtain understanding of the entity Obtain understanding of internal control

52 Conclusion > Discussion > Enquiry > Professional Scepticism > Understanding risk of fraud > Revenue Recognition mandatory significant risk of fraud > Auditor response > Consider Management Override > Documentation > Communication & Reporting


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