1. Fraud Auditing
Chapter 11
By arens et.al.,

2. Learning Objective 1 Define fraud and distinguish
between fraudulent financial
reporting and misappropriation
of assets.

3. Types of Fraud Fraudulent financial reporting
Misappropriation of assets

4. Learning Objective 2 Describe the fraud triangle and
identify conditions for fraud.

5. The Fraud Triangle Incentives/Pressures Opportunities
Attitudes/Rationalization

6. Examples of Risk Factors for Fraudulent Reporting
Incentives/Pressures:
Financial stability or profitability is threatened by
economic, industry, or entity operating conditions
Excessive pressure exists for management to
meet debt requirements
Personal net worth is materially threatened

7. Examples of Risk Factors for Fraudulent Reporting
Opportunities:
There are significant accounting estimates that
are difficult to verify
There is ineffective oversight over financial
reporting
High turnover or ineffective accounting, internal
audit, or information technology staff exists

8. Examples of Risk Factors for Fraudulent Reporting
Attitudes/Rationalization:
Inappropriate or inefficient communication
and support of the entity’s values is evident
A history of violations of laws is known
Management has a practice of making
overly aggressive or unrealistic forecasts

9. Examples of Risk Factors for Misappropriation of Assets
Incentives/Pressures:
Personal financial obligations create pressure
to misappropriate assets
Adverse relationships between management
and employees motivate employees to
misappropriate assets

10. Examples of Risk Factors for Misappropriation of Assets
Opportunities:
There is a presence of large amounts of cash
on hand or inventory items
There is an inadequate internal control over
assets

11. Examples of Risk Factors for Misappropriation of Assets
Attitudes/Rationalization:
Disregard for the need to monitor or reduce
risk of misappropriating assets exists
There is a disregard for internal controls

12. Learning Objective 3 Understand the auditor’s
responsibility for assessing
the risk of fraud and detecting
material misstatements due to
fraud.

13. Assessing the Risk of Fraud
SAS 99 provides guidance to auditors
in assessing the risk of fraud.
SAS 1 states that, in exercising professional
skepticism, an auditor “neither assumes that
management is dishonest nor assumes
unquestioned honesty.”

14. Sources of Information Gathered to Assess Fraud Risks
Communication
among audit team
Inquiries of
management
Risk
factors
Analytical
procedures
Other
information
Identified risks of material misstatements due to fraud

15. Documenting Fraud Assessment
Discussion
Procedures
Specific risks
Reasons
Other conditions and analytical relationships
Nature of communications

16. Learning Objective 4 Identify corporate governance
and other control environment
factors that reduce fraud risks.

17. Corporate Governance Oversight to Reduce Fraud Risks
1. Culture of honesty and high ethics
2. Management's responsibility
to evaluate risks of fraud
3. Audit committee oversight

18. Example Elements for a Code of Conduct
Organizational code of conduct
General employee conduct
Conflicts of interest
Outside activities, employment, and directorships

19. Example Elements for a Code of Conduct
Relationships with clients and suppliers
Gifts, entertainment, and favors
Kickbacks and secret commissions
Organization funds and other assets

20. Example Elements for a Code of Conduct
Organization records and communications
Dealing with outside people and organizations
Prompt communications
Privacy and confidentiality

21. Organizational Factors Contributing to Risk of Fraud
Collusion between
employees and
third parties 48 31 33
Inadequate
internal
controls 39 58 59
Management
override of
internal controls 31 36 36
2003
1998
1994

22. Organizational Factors Contributing to Risk of Fraud
Collusion between
employees and
management 15 19 23
Lack of control
over management
by directors 12 11 6
Ineffective or
nonexistent ethics or
compliance program 10 8 7
2003
1998
1994

23. Learning Objective 5
Develop responses to identified
fraud risks.

24. Responding to the Risk of Fraud
Change the overall conduct of the audit
to respond to identified fraud risks.
Design and perform audit procedures
to address identified risks.
Design and perform procedures to
address the risk of management
override of controls.

25. Learning Objective 6 Recognize specific fraud risk
areas and develop procedures
to detect fraud.

26. Initial Detection Method for Million Dollar Schemes
42.3%
Tip
46.2%
22.8%
By Accident
20.0%
Type of Detection
18.6%
Internal Audit
19.4%
16.7%
Internal Controls
$1,000,000+
23.3%
15.8%
All Cases
External Audit
9.1%
6.0%
Notified By Police
3.2% 0%
10%
20%
30%
40%
50%
Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.

27. Specific Fraud Risk Areas
Revenue and accounts receivable fraud risks
Inventory fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk

28. Learning Objective 7 Understand interview techniques
and other activities after fraud
is suspected.

29. Responding to Misstatements That May Be the Result of Fraud
When fraud is suspected, the auditor gathers
additional information to determine whether
fraud actually exists.

30. Types of Inquiry Techniques
Informational inquiry
Assessment inquiry
Interrogative inquiry
Evaluating responses
Listening techniques
Observing behavioral cues

31. End of Chapter 11