1. Management Fraud and Audit Risk
Chapter 4
Management Fraud and Audit Risk
ACCT-4080
Chapter 3

2. 1. Errors, Fraud, and Noncompliance
Definitions Errors - unintentional Fraud (irregularities) - intentional Noncompliance with laws and regulations (Illegal acts) violations of the law
Auditor’s responsibilities
History Errors & Fraud: SAS 1, SAS 16, SAS 53, SAS 82, SAS 99 Illegal Acts: SAS 54
ACCT-4080
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3. 1. Errors, Fraud, and Noncompliance (continued)
Errors and Fraud (AU-C 240)
design and conduct the audit to provide reasonable assurance that material errors and fraud will be discovered, and report the findings to appropriate parties
Noncompliance with laws and regulations (Illegal Acts) (AU-C 250)
direct effect noncompliance — same
indirect effect noncompliance —
have general level of awareness and act on those discovered
make inquiries
carry out some procedures to identify noncompliance
Questions
ACCT-4080
Chapter 3

4. 1. Errors, Fraud, and Noncompliance (continued)
Steps involved in Considering the Risk of Fraud
Staff discussion
Obtain information needed to identify risks
Identify risks
Assess identified risks
Respond to results of assessment
Evaluate audit evidence
Communicate about fraud
Document consideration of fraud
Chapter 6

5. 2. Fraud Causes of Misstatements Causes Errors Fraud
Misappropriation Fraudulent
of Assets Financial
Reporting
ACCT-4080
Chapter 3

6. 2. Fraud (continued)
EXHIBIT 3.1
ACCT-4080
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7. 2. Fraud (continued)
Fraudulent financial reporting (cooking the books) (management fraud)
falsification of financial statements
falsification or omissions of transactions
Misappropriation of assets (employee fraud)
larceny
embezzlement
ACCT-4080
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8. 2. Fraud (continued) Overview of Fraud (outline) costs discovery
victims
perpetrators
common characteristics
types
ACCT-4080
Chapter 3

9. The Fraud Triangle PRESSURE PERCEIVED OPPORTUNITY RATIONALIZATION
ISU WU
Summer 2009
* Misstatements

10. 2. Fraud (continued) Prevalence of fraud Current frauds
Reasons to study fraud
Fraud related job opportunities
ACFE
CFE
ACCT-4080
Chapter 3

11. 3. Audit Risk
ACCT-4080
Chapter 3

12. 3. Audit Risk AU-C 320 – Audit Risk General business risks
Engagement risk
Audit Risk Model
AR = RMM x DR
AR = IR x CR x DR
AR = IR x CR x TD x AP
Audit Risk definition
the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated
the danger that the auditor will fail to detect material misstatements in the financial statements
at financial statement level; at account balance level
ACCT-4080
Chapter 3

13. 3. Audit Risk (continued)
Risk of Material Misstatement
product of inherent risk and control risk
consider at entity level and account/assertion level
Inherent Risk
the susceptibility of an account balance to error assuming there are no controls
based on auditor’s judgment considering understanding of entity, nature of account (routine, systematic processing, complexity, etc), and fraud considerations
Control Risk
the risk that the ICS will not prevent or detect a material error on a timely basis
based on tests of control’s effectiveness
ACCT-4080
Chapter 3

14. 3. Audit Risk (continued)
Detection Risk
the risk that the auditor’s procedures will not detect a material error
the product of Tests of Details Risk (TD) and Substantive Analytical Procedures Risk (AP)
Tests of Details Risk
the risk that tests of details will not detect a material error
Substantive Analytical Procedures Risk
the risk that analytical procedures (or other procedures that do not utilize sampling) will not detect a material error
ACCT-4080
Chapter 3

15. 3. Audit Risk (continued)
Risks defined in negative
Auditor’s control over risks
Relationship between
RMM and DR
DR and amount of substantive testing
ACCT-4080
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16. 3. Audit Risk (continued)
Subjectively considering Audit Risk
Quantifying Audit Risk
not required
DR = AR / IR x CR
TD = AR / IR x CR x AP
Questions
ACCT-4080
Chapter 3

17. 3. Audit Risk (continued)
General guidelines
Inherent Risk
High > 60%
Moderate 40% %
Low < 40%
Control Risk
Maximum = 100%
High > 70%
Moderate 40% %
Very Low < 10%
ACCT-4080
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18. 3. Audit Risk (continued)
Analytical Procedures Risk
High > 50%
Moderate 20% %
Low % %
Very Low < 10%
ACCT-4080
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19. 4. Analytical Procedures
Definition
Uses in an audit
planning stage
as a substantive test (SAP)
final review stage
Required use
ACCT-4080
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20. 4. Analytical Procedures (Continued)
In planning stage
enhances auditor’s understanding
identifies risk areas
uses highly aggregated data
generally financial data
ACCT-4080
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21. 4. Analytical Procedures (Continued)
Steps
develop an expectation
define a significant difference
calculate predictions and compare with recorded amount
investigate significant differences
document each step
ACCT-4080
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22. 4. Analytical Procedures (Continued)
Substantive analytical procedures
based on level of DR
based on auditor judgment
balance sheet data vs. income statement data
often uses non-financial data
ACCT-4080
Chapter 3

23. 4. Analytical Procedures (Continued)
In final evaluation stage
uses aggregated data
usually financial data
review same data used in planning stage
Questions
ACCT-4080
Chapter 3

24. 5. Review Questions for Discussion
Chapter 4
4.6
4.7
4.8
4.9
4.12
4.14
4.17
ACCT-4080
Chapter 3