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

2. Objectives The Enron debacle AICPA Response AUASB Response Conclusion
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. The US Sneezes the World catches Cold
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The Enron Debacle
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The US Sneezes the World catches Cold

5. Protection of Investors and the Public Pre - EnronUS
Australia
GAAP – Generally Accepted Accounting Principles GAAS – Generally Accepted Auditing Standards SAS – Statements on Auditing Standards & All Professional Ethics
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 2nd 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 s 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 Effective Impact Example SAS 96
January 2002
Dealt with record retention policies and requirement for auditor to document all significant decisions or judgements
Approval by auditor of client application of GAAP
SAS 98
Made many revisions and amendments to previous statements
Changes to GAAS
Relationship between GAAS & Quality Control Standards
Audit risk and materiality concepts in audits
SAS 99
Outlines what fraud is and reaffirms necessity to gather all information
Revenue Recognition recognised as a fraud risk

16. Ongoing update and refinement of the existing Fraud Standard
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AUASB Response
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Ongoing update and refinement of the existing Fraud Standard

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

18. Heading Style
AUS Issued January 2002
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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. ASA 240 Issued April 2006 The Auditors Responsibility to
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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