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1. Define the various types of fraud that affect organizations2. Define the fraud triangle and describe its three elements 3. Describe implications for auditors of recent fraudulent financial
reporting cases and the third COSO report on fraud4. Discuss auditors’ fraud-related responsibilities and users’ related
expectations5. Explain how various requirements in the Sarbanes–Oxley Act of
2002 are designed to help prevent the types frauds perpetrated in the late 1990s and early 2000s
6. Define corporate governance, identify the parties involved, and describe their respective activities
• An intentional act involving use of deception that results in a misstatement of financial statements• Two types of misstatements• Misappropriation of assets• Fraudulent financial reporting
• Different from errors • Errors occur unintentionally
• The intentional manipulation of reported financial results to misstate the economic condition of the organization• Common ways • Manipulation, falsification, or alteration of accounting
records or supporting documents• Misrepresentation or omission of events or
transactions• Misapplication of accounting principles
IMPLICATIONS TO KEEP IN MIND WHEN CONDUCTING AN AUDIT
• Pressure created for top management by the analyst following and earnings expectations• Before completing an audit, sufficient time should be allowed
to examine major year-end transactions:• Especially if there are potential problems with revenue
• Understanding complex transactions to determine:• Their economic substance• The parties that have economic obligations
• Understanding and analyzing weaknesses in an organization’s internal controls
• Major findings• The amount and incidence of fraud remains high• The median size of company perpetrating the fraud rose
tenfold • Heavy involvement in fraud by the CEO and/or CFO• Most common fraud involved revenue recognition• One-third of the companies changed auditors during the
latter part of the fraud• Majority of the frauds took place at companies that
MITIGATING THE RISK OF FRAUDULENT FINANCIAL REPORTING
• Center for Audit Quality recommends three ways in which individuals involved in the financial reporting process can mitigate risk of fraudulent reporting• Need to acknowledge the existence of a strong, highly
ethical tone at the top of an organization• Need to consistently exercise professional skepticism in
evaluating and/or preparing financial reports• Need to understand the role of strong communication
• Broad legislation mandating standard setting for audits of public companies and standards for corporate governance• Applies to publicly traded companies • Not privately held organizations
• Read Exhibit 2.4 carefully to understand the sections of SOX and the various features of the legislation
• A process by which owners and creditors exert control and require accountability for resources entrusted to organizations• Owners elect board of directors to provide: • Oversight of organizations’ activities• Accountability to stakeholders
• Board of directors: The major representative of stockholders, who ensure that the organization is run according to the organization’s charter and that there is proper accountability• Audit committee: A subcommittee of the board of
directors responsible for monitoring audit activities and serving as a surrogate for the interests of shareholders
• Board of directors and its audit committee oversee management• Expected to protect stockholders’ rights• Ensure that controls exist to prevent and detect fraud
• Stakeholders: Anyone who is influenced, either directly or indirectly, by actions of a company