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Fraud Auditing

Chapter 11

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Learning Objective 1

Define fraud and distinguish


between fraudulent financial
reporting and misappropriation
of assets.

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Types of Fraud

Fraudulent financial reporting

Misappropriation of assets

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Learning Objective 2

Describe the fraud triangle and


identify conditions for fraud.

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The Fraud Triangle

Incentives/Pressures

Opportunities Attitudes/Rationalization

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Examples of Risks Factors for
Fraudulent Reporting

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.

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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, or information technology staff exists.

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Examples of Risks Factors for
Fraudulent Reporting

Inappropriate or inefficient communication


and support of the entitys values is evident.

A history of violations of laws is known.

Management has a practice of making


overly aggressive or unrealistic forecasts.

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Examples of Risks Factors for
Misappropriation of Assets

Personal financial obligations create pressure to


misappropriate assets.

Adverse relationships between management


and employees motivate employees to
misappropriate assets.

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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.

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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.

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Learning Objective 3

Understand the auditors


responsibility for assessing
the risk of fraud and detecting
material misstatements due to
fraud.

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Assessing the Risk of Fraud

SAS 99 provides guidance to auditors


in assessing the risk of fraud.

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Professional Skepticism

SAS 1 states that, in exercising professional


skepticism, an auditor neither assumes that
management is dishonest nor assumes
unquestioned honesty.

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Sources of Information Gathered
to Assess Fraud Risks
Communication Inquiries of Risk Analytical Other
among audit team management factors procedures information

Identified risks of material misstatements due to fraud

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Documenting Fraud Assessment

Discussion Procedures

Specific risks Reasons

Results Other conditions

Nature of communications

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Learning Objective 4

Identify corporate governance


and other control environment
factors that reduce fraud risks.

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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.

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Example Elements for a Code of
Conduct
Organizational code of conduct

General employee conduct

Conflicts of interest

Outside activities, employment, and directorships

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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

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Example Elements for a Code of
Conduct
Organization records and communications

Dealing with outside people and organizations

Prompt communications

Privacy and confidentiality

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

2003 1998 1994


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

2003 1998 1994


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Learning Objective 5

Develop responses to identified


fraud risks.

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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.

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Learning Objective 6

Recognize specific fraud risk


areas and develop procedures
to detect fraud.

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Rates of Fraud Occurrence
Theft of assets 49
22
Check fraud 40
26
Expense account 36
abuse 13

Credit card fraud 20


13

Payroll fraud 12
3
2003 1998
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Rates of Fraud Occurrence
Conflict of interest 12
9
Inventory theft 11
11
Kickbacks 9
6
Financial reporting 7
fraud 3

2003 1998
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Specific Fraud Risk Areas

Revenue and accounts receivable fraud risks

Inventory fraud risks

Purchases and accounts payable fraud risks

Other areas of fraud risk

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Learning Objective 7

Understand interview techniques


and other activities after fraud
is suspected.

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Methods of Uncovering Fraud

77%
Internal controls 51%
52%
65%
Internal audit 43%
47%
Notification 63%
by employee 58%
51%

2003 1998 1994


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Methods of Uncovering Fraud

54%
Accident 37%
28%
41%
Anonymous tip 35%
26%
Notification 34%
by customer 41%
34%

2003 1998 1994


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Methods of Uncovering Fraud

Notification by 19%
regulatory or law 16%
enforcement agency 8%
Notification 16%
by vendor 11%
15%
12%
External audit 4%
5%

2003 1998 1994


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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.

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Types of Inquiry Techniques

Informational inquiry

Assessment inquiry

Interrogative inquiry

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Types of Inquiry Techniques

Evaluating responses

Listening techniques

Observing behavioral cues

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End of Chapter 11

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