Chapter 11
Considering the Risk of Fraud
Chapter 11
Considering the
Risk of Fraud
Define fraud and distinguish between fraudulent financial reporting and
misappropriation of assets.
Describe the fraud triangle and identify conditions for fraud.
Understand the auditor’s responsibility for
assessing the risk of fraud and detecting
material misstatements due to fraud.
Identify corporate governance and other control environment factors that reduce fraud risks.
Develop responses to identified fraud risks.
Recognize specific fraud risk areas and
develop procedures to detect fraud.
Define fraud and distinguish between fraudulent financial reporting and misappropriation of
assets.
1
Management Fraud
Fraudulent financial reporting
Misappropriation of assets
Describe the fraud triangle and identify conditions for fraud.
2
Incentives/Pressures
Incentives/Pressures:
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
Opportunities:
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
Attitudes/Rationalization:
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
Incentives/Pressures:
Personal financial obligations create pressure to misappropriate assets
Adverse relationships between management and employees motivate employees to
misappropriate assets
Opportunities:
There is a presence of large amounts of cash on hand or inventory items
There is an inadequate internal control over assets
Attitudes/Rationalization:
Disregard for the need to monitor or reduce risk of misappropriating assets exists
There is a disregard for internal controls
Understand the auditor’s responsibility for assessing the risk of fraud and detecting
material misstatements due to fraud.
3
Auditing standards provide guidance to Auditors in assessing the risk of fraud.
Auditing standards state that, in exercising Professional skepticism, an auditor
“neither assumes that management is
dishonest nor assumes unquestioned honesty.”
Discussion among engagement team
Procedures performed to assess risk
Specific risks and audit response
Reasons supporting conclusions
Results of procedures performed
Other conditions and analytical relationships
Nature of communications
Identify corporate governance and other control environment factors
that reduce fraud risks.
4
1. Culture of honesty and high ethics 2. Management's responsibility
to evaluate risks of fraud 3. Audit committee oversight
Organizational code of conduct
General employee conduct
Conflicts of interest
Outside activities, employment, and
Relationships with clients and suppliers
Gifts, entertainment, and favors
Kickbacks and secret commissions
Organization funds and other assets
Organization records and communications
Dealing with outside people and organizations
Prompt communications
Develop responses to identified fraud risks.
5
Change the overall conduct of the audit to respond to identified fraud risks.
Design and perform audit procedures to address fraud risks.
Design and perform procedures to address the risk of management override of controls.
Recognize specific fraud risk areas and develop procedures to detect fraud.
6
Revenue and accounts receivable fraud risks
Inventory fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk
7
Informational
Assessment
Interrogative Evaluating
responses Listening
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