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SAS 99 “Consideration of Fraud in a Financial Statement Audit” (October 2002)

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Presentation on theme: "SAS 99 “Consideration of Fraud in a Financial Statement Audit” (October 2002)"— Presentation transcript:

1 SAS 99 “Consideration of Fraud in a Financial Statement Audit” (October 2002)

2 2 Profession Under Pressure Evening News

3 3 SAS 99 “Consideration of Fraud in a Financial Statement Audit” ( O ctober 2002) 1. Supersedes SAS 82 (AU 316) on Fraud. 2. Modifies SAS 1 (AU 230) on Due Professional Care to Better Describe Fraud and Collusion. 3. Modifies SAS 85 (AU 333) on Mgmt Representations to Require Inquiry of Mgmt as to Fraud and Fraud Risk.

4 4 Basic Responsibility “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” No Change in Overall Responsibility. Same Detection Responsibilities for Misstatements – Whether Errors/Mistakes or Fraudulent (Intentional).

5 5 Significant Changes Better Definition & Increased Emphasis on Professional Skepticism. Re-categorizes Fraud Risk Indicators Under the 3 Major Causes for Fraud. Requires Specific Inquiries with Mgmt & Others on Fraud and the Risk of Fraud. Calls for Unpredictable Audit Tests. Includes Procedures to Specifically Test for Mgmt Override of Internal Controls.

6 6 Definition of Fraud “An intentional act that results in a material misstatement in financial statements that are the subject of an audit.” Two Types of Fraud 1. Fraudulent Financial Reporting 2. Misappropriation/Theft of Assets

7 7 What is a Misstatement? Amounts or Disclosures in F.S. are Misrepresented or Just Omitted. Could be Misapplication of GAAP. Effect: Causes F.S. Not to Conform to GAAP. Generally Designed to Deceive F.S. Users When Caused by Financial Reporting Fraud.

8 8 Causes/Conditions for Fraud 1.Motivation: Incentives or Pressure 2.Opportunity: Weak, Ineffective Internal Controls or Ability for Mgmt Override 3.Management & Employee Attitudes or Rationalizations and Ethical Values  All 3 Are Not Needed for Fraud to Occur and Each One Can Have Varying Values. But, The Higher the Value of All 3, the Higher the Risk For Fraud of Both Types.

9 9 SAS 99 Process 1. Developing Professional Skepticism 2. Identifying the Risk of Material Fraud 3. Assessing Impact of Risk on Audit 4. Responding to the Risks 5. Documentation

10 10 Professional Skepticism SAS 99 Says This is the Key to Fraud Detection. Defined as an Attitude or Mindset That Includes a Questioning Mind and a Critical Assessment of Audit Evidence Without any Beliefs About Management’s Honesty or Integrity.

11 11 Identifying Fraud Risks 1. Inquiries of Management & Others 2. Results of Analytical Procedures 3. SAS 99 List of Fraud Risk Factors 4. Other Information

12 12 Inquiries 1. Inquiries of Management 2. Inquiries of Others at the Client Audit Committee Internal Auditors Audit Contacts Operational Management In-house Legal Initiators of Complex/Unusual Transactions Objectives: Identify Fraud Risk Indicators, Corroborate Management Answers & Identify Inconsistencies.

13 13 Identifying Fraud Risks Ask Management About: Knowledge of Fraud or Suspected Fraud Aware of Any Fraud Allegations Understanding of Fraud Risks for Entity

14 14 Identifying Fraud Risks Ask Management About: Knowledge of Fraud or Suspected Fraud Aware of Any Fraud Allegations Understanding of Fraud Risks for Entity Programs & Controls to Prevent, Deter or Detect Fraud & Monitoring Thereof Methods Used to Communicate Views on Business Practices & Ethical Behavior

15 15 Identifying Fraud Risks Ask Management About: Knowledge of Fraud or Suspected Fraud Aware of Any Fraud Allegations Understanding of Fraud Risks for Entity Programs & Controls to Prevent, Deter or Detect Fraud & Monitoring Thereof. Methods Used to Communicate Views on Business Practices & Ethical Behavior What Management Has Reported to the Audit Committee on Fraud and Related Programs & Controls. And – Share Results With Audit Committee

16 16 Identifying Fraud Risks Analytical Procedures GAAS-Required for Planning & Final Overall Review of Audit Adjusted F.S. Looking for Unusual or Unexpected A/C Balances, Ratios or Trends. SAS 99 Highlights Use to Identify Risks for Improper Revenue Recognition.

17 17 Earnings Management

18 18 SAS 99 Fraud Risk Factors  Now Categorized Under the 3 Causes or Conditions for Fraud: 1. Motivation (Incentives/Pressure) 2. Opportunity 3. Attitudes/Values/Rationalizations  Basically, Conditions or Events Which Indicate Existence of the Above 3 Causes/Conditions.  Risk Factors Included in an Appendix.

19 19 Identifying Fraud Risks SAS 99 - Other Information Sources Audit Team Discussions Client QC Procedures for Accepting or Continuing Clients Review of Interim F.S. and Information Inherent Risk Factors

20 20 Audit Team Discussions Include All Key Audit Team Members Emphasize Professional Skepticism Assess Client’s Susceptibility to Fraud How Mgmt Could Perpetrate/Conceal Fraudulent Financial Reporting How & Where F.S. Might Be Misstated How Assets Could be Misappropriated How to Respond to the Risks

21 21 Evaluating Fraud Risks Size & Structure of Organization Matters as Some Risks Are Unavoidable in Small Entities or Entities With Many Locations.

22 22 Evaluating Fraud Risks Size & Structure of Organization Matters as Some Risks Are Unavoidable in Small Entities or Entities With Many Locations. Identify A/Cs or Classes of Transactions With Increased Risk.

23 23 Evaluating Fraud Risks Size & Structure of Organization Matters as Some Risks Are Unavoidable in Small Entities or Entities With Many Locations. Identify A/Cs or Classes of Transactions With Increased Risk. Consider Internal Controls Which Address the Increased Risks.

24 24 Evaluating Fraud Risks Size & Structure of Organization Matters as Some Risks Are Unavoidable in Small Entities or Entities With Many Locations. Identify A/Cs or Classes of Transactions With Increased Risk. Consider Internal Controls Which Address the Increased Risks. But, MUST Consider Risks for Improper Revenue Recognition and Management Override of Internal Controls.

25 25 Responding to Fraud Risks Depends on: Nature & Significance of Fraud Risks Identified. Entity’s Programs and Controls That Address These Risks. If Deemed Not Practical to Design Appropriate Audit Tests for High Risk, WITHDRAW.

26 26 Responding to Fraud Risks (con’t) Assign Appropriate Personnel

27 27 Responding to Fraud Risks (con’t) Assign Appropriate Personnel Assess GAAP Selection Bias

28 28 Responding to Fraud Risks (con’t) Assign Appropriate Personnel Assess GAAP Selection Bias Design Additional or Different Audit Tests as Corroborating Evidence and Consider Optimal Timing & Locations. Be Unpredictable – (Changes from past to include types of audit tests, timing & locations.)

29 29 Responding to Fraud Risks (con’t) Assign Appropriate Personnel Assess GAAP Selection Bias Design Additional or Different Audit Tests as Corroborating Evidence and Consider Optimal Timing & Locations. Be Unpredictable – (Changes from past to include types of audit tests, timing & locations.) Examples of Response for Various Types of Fraud Risks Included in SAS 99.

30 30 Responding to Fraud Risks Management Override Because of Management’s Ability to Override Internal Controls, It is Highly Unlikely Auditor’s Response to Fraud Risks Can be Solely Increased Tests of Controls.

31 31 Responding to Fraud Risks Management Override (con’t) Consider Testing: Adjusting Journal Entries

32 32 Responding to Fraud Risks Management Override (con’t) Consider Testing: Adjusting Journal Entries Other Adjustments to F.S. (Done during F.S. Preparation; off books) Non-Standard Journal Entries

33 33 Responding to Fraud Risks Management Override (con’t) Consider Testing: Adjusting Journal Entries Other Adjustments to F.S. (off books) Non-Standard Journal Entries Accounting Estimates, Including Comparison to Reliability of Prior Year’s Estimates

34 34 Responding to Fraud Risks Management Override (con’t) Consider Testing: Adjusting Journal Entries Other Adjustments to F.S. (off books) Non-Standard Journal Entries Accounting Estimates, Including Comparison to Prior Year’s Reliability Significant Unusual Transactions (Form vs Substance, Business Rationale, Related Parties (incl. SPEs) and If Audit Committee Briefed)

35 35 Updating Fraud Risk Assessment Must Be Done Throughout the Audit, for: Discrepancies in Accounting Records Missing Audit Evidence; No Originals Altered Documents/Records Subsidiary/Control A/C Differences

36 36 Updating Fraud Risk Assessment (con’t) Inconsistencies in Audit Evidence Uncooperative Mgmt or Employees  Access to Records/Employees or Delays  Time Constraints  Objections to Audit Tests/Procedures  Unwillingness to Make Proposed F.S. Adjustments

37 37 Updating Fraud Risk Assessment (con’t) Results of Analytical Procedures Ones Done as Substantive Tests Ones Done as Part of Final Review of Audit Adjusted F.S., esp. Revenue

38 38 Updating Fraud Risk Assessment (con’t) Results of Analytical Procedures (con’t) Examples of Analytical Procedures Less Likely to be Manipulated (use of industry data, non-financial data) Included in SAS 99.

39 39 Updating Fraud Risk Assessment (con’t) Final Overall Assessment Audit Team Discussion of Fraud Risks from Conducting Entire Audit

40 What If Fraud-Caused Misstatements Found? Auditor to Assess: Materiality of Accounts Involved Level of Employee(s) Involved Implications on Other Aspects of the Audit and Effect of Misstatement on F.S. Suggest Client Seek Legal Counsel

41 What If Fraud-Caused Misstatements Found? (con’t) Consider Withdrawing, If: Management’s Integrity in Question Lack of Diligence/Cooperation by Management or Board of Directors in the Investigation

42 42 Communicating Possible Fraud Discuss With Mgmt (1 Level Higher), Even If Immaterial. Discuss with Audit Committee If Senior Management Involved or Fraud Results in Material Misstatement to F.S.

43 43 Communicating Possible Fraud Discuss With Mgmt (1 Level Higher), Even If Immaterial. Discuss with Audit Committee If Senior Management Involved or Results in Material Misstatement to F.S. Reach Understanding with Audit Committee on Communicating Other Fraud. Consider Weaknesses in Internal Controls to Prevent, Deter or Detect Fraud as “Reportable Conditions”.

44 44 Communicating to Outsiders Generally, Not Required, Except:  Audits Under Gov’t Auditing Standards  Response to Subpoena  Successor Auditor, with Client’s OK  SEC Act of 1934 if Illegal Act  Indirectly to SEC (Form 8-K) for Change in Auditors, If Auditors Fired/Withdraw

45 45 Required Documentation Audit Team Discussions (How, When, Who and What) Procedures Performed to Identify and Assess Fraud Risks Specific Fraud Risks Identified & Auditor’s Response to the Risks

46 46 Required Documentation (con’t) If No Risks Identified for Fraudulent Revenue, Basis for That Conclusion Results of Tests to Address Risks of Management Override of Internal Controls Audit Testing-Identified Fraud Risks Fraud-Related Communications

47 To Address Implementation Questions, AICPA Issued: “Fraud Detection in a GAAS Audit - An Auditor’s Field Guide” Publication Date: December 2002

48 Questions?


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