Ch 11 Fraud.ppt

• 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 Financial stability or profitability is threatened by economic, industry, or entity operating conditions. Incentives/Pressures Excessive pressure exists for management to meet debt requirements. Personal net worth is materially threatened. 5. Examples of Risks Factors for Fraudulent Reporting 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. Opportunities 6. Examples of Risks Factors for Fraudulent Reporting Little communication and support of theentitys core values is evident. A history of violations of laws is known. Management has a practice of making overly aggressive or unrealistic forecasts. Attitudes/Rationalization 7. Examples of Risks Factors for Misappropriation of Assets Personal financial obligations create pressure to misappropriate assets. Incentives/Pressures Adverse relationships between management and employees motivate employees to misappropriate assets. 8. Examples of Risks Factors for Misappropriation of Assets There is a presence of large amounts of cash on hand or inventory items. There is an inadequate internal control over assets. Opportunities 9. Examples of Risks Factors for Misappropriation of Assets Disregard for the need to monitor or reduce risk of misappropriating assets exists. There is a disregard for internal controls. Attitudes/Rationalization 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 31 36 36 19. Organizational Factors Contributing to Risk of Fraud Collusion between employees and management Lack of control over management be directors Ineffective or nonexistent ethics or compliance program 15 19 23 12 11 6 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 Inventory fraud risks Revenue and accounts receivable 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% 51% 24. Methods of Uncovering Fraud 2003 1998 1994 Accident Anonymous tip Notification by customer 54% 37% 28% 41% 35% 26% 34% 41% 34% 25. Methods of Uncovering Fraud 2003 1998 1994 Notification by regulatory or law enforcement agency Notification by vendor External audit 19% 16% 8% 16% 11% 15% 12% 4% 5% 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