Auditing and assurance services 14e by arens chapter 11

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
Management
Fraud

Fraudulent
financial
reporting

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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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Why Fraud Occurs

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Examples of Risk Factors
for Fraudulent Reporting
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

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Examples of Risk Factors
for Fraudulent Reporting
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

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Examples of Risk Factors
for Fraudulent Reporting
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

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Examples of Risk Factors
for Misappropriation of Assets
Incentives/Pressures:


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 Risk Factors
for Misappropriation of Assets

Opportunities:


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 Risk Factors
for Misappropriation of Assets
Attitudes/Rationalization:


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.
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

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Documenting Fraud Assessment
Discussion among engagement team
Procedures performed to assess risk
Specific risks and audit response
Reasons supporting conclusions
Other conditions and analytical
relationships
 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. Culture of honesty and high ethics
2. Management's responsibility
to evaluate risks of fraud
3. Audit committee oversight

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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

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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 fraud 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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