2 Learning Objective 1 Define fraud and distinguish between fraudulent financialreporting and misappropriationof 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 byeconomic, industry, or entity operating conditionsExcessive pressure exists for management tomeet debt requirementsPersonal net worth is materially threatened
7 Examples of Risk Factors for Fraudulent Reporting Opportunities:There are significant accounting estimates thatare difficult to verifyThere is ineffective oversight over financialreportingHigh turnover or ineffective accounting, internalaudit, or information technology staff exists
8 Examples of Risk Factors for Fraudulent Reporting Attitudes/Rationalization:Inappropriate or inefficient communicationand support of the entity’s values is evidentA history of violations of laws is knownManagement has a practice of makingoverly aggressive or unrealistic forecasts
9 Examples of Risk Factors for Misappropriation of Assets Incentives/Pressures:Personal financial obligations create pressureto misappropriate assetsAdverse relationships between managementand employees motivate employees tomisappropriate assets
10 Examples of Risk Factors for Misappropriation of Assets Opportunities:There is a presence of large amounts of cashon hand or inventory itemsThere is an inadequate internal control overassets
11 Examples of Risk Factors for Misappropriation of Assets Attitudes/Rationalization:Disregard for the need to monitor or reducerisk of misappropriating assets existsThere is a disregard for internal controls
12 Learning Objective 3 Understand the auditor’s responsibility for assessingthe risk of fraud and detectingmaterial misstatements due tofraud.
13 Assessing the Risk of Fraud SAS 99 provides guidance to auditorsin assessing the risk of fraud.SAS 1 states that, in exercising professionalskepticism, an auditor “neither assumes thatmanagement is dishonest nor assumesunquestioned honesty.”
14 Sources of Information Gathered to Assess Fraud Risks Communicationamong audit teamInquiries ofmanagementRiskfactorsAnalyticalproceduresOtherinformationIdentified risks of material misstatements due to fraud
15 Documenting Fraud Assessment DiscussionProceduresSpecific risksReasonsOther conditions and analytical relationshipsNature of communications
16 Learning Objective 4 Identify corporate governance and other control environmentfactors that reduce fraud risks.
17 Corporate Governance Oversight to Reduce Fraud Risks 1. Culture of honesty and high ethics2. Management's responsibilityto evaluate risks of fraud3. Audit committee oversight
18 Example Elements for a Code of Conduct Organizational code of conductGeneral employee conductConflicts of interestOutside activities, employment, and directorships
19 Example Elements for a Code of Conduct Relationships with clients and suppliersGifts, entertainment, and favorsKickbacks and secret commissionsOrganization funds and other assets
20 Example Elements for a Code of Conduct Organization records and communicationsDealing with outside people and organizationsPrompt communicationsPrivacy and confidentiality
21 Organizational Factors Contributing to Risk of Fraud Collusion betweenemployees andthird parties483133Inadequateinternalcontrols395859Managementoverride ofinternal controls313636200319981994
22 Organizational Factors Contributing to Risk of Fraud Collusion betweenemployees andmanagement151923Lack of controlover managementby directors12116Ineffective ornonexistent ethics orcompliance program1087200319981994
23 Learning Objective 5Develop responses to identifiedfraud risks.
24 Responding to the Risk of Fraud Change the overall conduct of the auditto respond to identified fraud risks.Design and perform audit proceduresto address identified risks.Design and perform procedures toaddress the risk of managementoverride of controls.
25 Learning Objective 6 Recognize specific fraud risk areas and develop proceduresto detect fraud.
26 Initial Detection Method for Million Dollar Schemes 42.3%Tip46.2%22.8%By Accident20.0%Type of Detection18.6%Internal Audit19.4%16.7%Internal Controls$1,000,000+23.3%15.8%All CasesExternal Audit9.1%6.0%Notified By Police3.2%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 risksInventory fraud risksPurchases and accounts payable fraud risksOther areas of fraud risk
28 Learning Objective 7 Understand interview techniques and other activities after fraudis suspected.
29 Responding to Misstatements That May Be the Result of Fraud When fraud is suspected, the auditor gathersadditional information to determine whetherfraud actually exists.