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 entity’s 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 auditor’s
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
among audit team
Inquiries of
management
Risk
factors
Analytical
procedures
Other
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
employees and
third parties
Inadequate
internal
controls
Management
override of
internal controls
2003
1998
48
31
33
39
58
59
31
36
36
1994
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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
2003
1998
15
19
23
12
11
6
10
8
7
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
abuse
36
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
fraud
7
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
Internal controls
77%
51%
52%
Internal audit
65%
43%
47%
Notification
by employee
63%
58%
51%
2003
1998
1994
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Methods of Uncovering Fraud
Accident
54%
37%
28%
Anonymous tip
41%
35%
26%
Notification
by customer
34%
41%
34%
2003
1998
1994
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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
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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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