1. Fraud Auditing
Chapter 11

2. Types of Fraud Fraudulent financial reporting
Misappropriation of assets

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

4. Examples of Risks 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.

5. Examples of Risks 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 staff.

6. Examples of Risks Factors for Fraudulent Reporting
Attitudes/Rationalization
Little communication and support of the
entity’s core values is evident.
A history of violations of laws is known.
Management has a practice of making
overly aggressive or unrealistic forecasts.

7. Examples of Risks 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.

8. Examples of Risks 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.

9. Examples of Risks 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.

10. Assessing the Risk of Fraud
SAS 99 provides guidance to auditors
in assessing the risk of fraud.

11. Professional Skepticism
SAS 1 states that, in exercising professional
skepticism, an auditor “neither assumes that
management is dishonest nor assumes
unquestioned honesty.”

12. 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

13. Identify corporate governance
and other control environment
factors that reduce fraud risks.

14. Corporate Governance Oversight to Reduce Fraud Risks
1. Create and maintain a culture of honesty
and high ethics.
2. Evaluate fraud risks and implement programs
and controls to mitigate identified fraud risks.
3. Develop an appropriate fraud oversight process.

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

16. 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

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

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

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

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

21. 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.

22. Specific Fraud Risk Areas
Revenue and accounts receivable fraud risks
Inventory fraud risks
Purchases and accounts payable fraud risks

23. Methods of Uncovering Fraud
2003
1998
1994
Internal controls
Internal audit
Notification
by employee
77%
51%
52%
65%
43%
47%
63%
58%

24. Methods of Uncovering Fraud
Accident
54%
37%
28%
Anonymous tip
41%
35%
26%
Notification
by customer
34%
41%
34%
2003
1998
1994

25. Methods of Uncovering Fraud
Notification by
regulatory or law
enforcement agency
19%
16% 8%
Notification
by vendor
16%
11%
15%
External audit
12% 4% 5%
2003
1998
1994

26. 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.

27. End of Chapter 11