©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 1
Fraud Auditing
Chapter 11
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 22
Learning Objective 1
Define fraud and distinguish
between fraudulent financial
reporting and misappropriation
of assets.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 33
Types of Fraud
Fraudulent financial reporting
Misappropriation of assets
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 44
Learning Objective 2
Describe the fraud triangle and
identify conditions for fraud.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 55
The Fraud Triangle
Incentives/Pressures
Opportunities Attitudes/Rationalization
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 66
Examples of Risk Factorsfor Fraudulent Reporting
Financial stability or profitability is threatened byeconomic, industry, or entity operating conditions
Excessive pressure exists for management tomeet debt requirements
Personal net worth is materially threatened
Incentives/Pressures:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 77
Examples of Risk Factorsfor Fraudulent Reporting
There are significant accounting estimates thatare difficult to verify
There is ineffective oversight over financialreporting
High turnover or ineffective accounting internalaudit, or information technology staff exists
Opportunities:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 88
Examples of Risk Factorsfor Fraudulent Reporting
Inappropriate or inefficient communicationand support of the entity’s values is evident
A history of violations of laws is known
Management has a practice of makingoverly aggressive or unrealistic forecasts
Attitudes/Rationalization:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 99
Examples of Risk Factorsfor Misappropriation of Assets
Personal financial obligations create pressureto misappropriate assets
Adverse relationships between managementand employees motivate employees tomisappropriate assets
Incentives/Pressures:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1010
Examples of Risk Factorsfor Misappropriation of Assets
There is a presence of large amounts of cashon hand or inventory items
There is an inadequate internal control overassets
Opportunities:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1111
Examples of Risk Factorsfor Misappropriation of Assets
Disregard for the need to monitor or reducerisk of misappropriating assets exists
There is a disregard for internal controls
Attitudes/Rationalization:
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1212
Learning Objective 3
Understand the auditor’s
responsibility for assessing
the risk of fraud and detecting
material misstatements due to
fraud.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1313
Assessing the Risk of Fraud
SAS 99 provides guidance to auditorsin assessing the risk of fraud.
SAS 1 states that, in exercising professionalskepticism, an auditor “neither assumes thatmanagement is dishonest nor assumesunquestioned honesty.”
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1414
Sources of Information Gatheredto Assess Fraud Risks
Communicationamong audit team
Inquiries ofmanagement
Riskfactors
Analyticalprocedures
Otherinformation
Identified risks of material misstatements due to fraud
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1515
Documenting Fraud Assessment Discussion
Specific risks
Procedures
Reasons
Results
Other conditions
Nature of communications
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1616
Learning Objective 4
Identify corporate governance
and other control environment
factors that reduce fraud risks.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1717
Corporate Governance Oversightto Reduce Fraud Risks
1. Culture of honesty and high ethics
2. Management's responsibilityto evaluate risks of fraud
3. Audit committee oversight
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1818
Example Elements for a Code of Conduct
Organizational code of conduct
General employee conduct
Conflicts of interest
Outside activities, employment, and directorships
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 1919
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
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2020
Example Elements for a Code of Conduct
Organization records and communications
Dealing with outside people and organizations
Prompt communications
Privacy and confidentiality
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2121
Organizational Factors Contributing to Risk of Fraud
2003 1998 1994
Collusion betweenemployees and
third parties
Inadequateinternalcontrols
Managementoverride of
internal controls
483133
395859
313636
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2222
Organizational Factors Contributing to Risk of Fraud
Collusion betweenemployees and
management
Lack of controlover management
by directors
Ineffective ornonexistent ethics orcompliance program
151923
1211 6
10 8 7
2003 1998 1994
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2323
Learning Objective 5
Develop responses to identified
fraud risks.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2424
Responding to the Risk of Fraud
Change the overall conduct of the auditto respond to identified fraud risks.
Design and perform audit proceduresto address identified risks.
Design and perform procedures toaddress the risk of managementoverride of controls.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2525
Learning Objective 6
Recognize specific fraud risk
areas and develop procedures
to detect fraud.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2626
Rates of Fraud Occurrence
2003 1998
Theft of assets 4922
Check fraud 4026
Expense accountabuse
3613
Credit card fraud 2013
Payroll fraud 12 3
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2727
Rates of Fraud Occurrence
2003 1998
Conflict of interest 12 9
Inventory theft 1111
Kickbacks 9 6
Financial reportingfraud
7 3
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2828
Specific Fraud Risk Areas
Inventory fraud risks
Revenue and accounts receivable fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 2929
Learning Objective 7
Understand interview techniques
and other activities after fraud
is suspected.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 3030
Methods of Uncovering Fraud
Internal controlsInternal auditNotification by employeeAccidentAnonymous tipNotification by customerNotification by regulatory or law enforcement agencyNotification by vendorExternal audit
77656354413419
1612
51435837354116
11 4
524751282634 8
15 5
(Percentages) 2003 1998 1994
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 3131
Responding to Misstatements That May Be the Result of Fraud
When fraud is suspected, the auditor gathersadditional information to determine whetherfraud actually exists.
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 11 - 3232
Types of Inquiry Techniques
Informational inquiry
Assessment inquiry
Interrogative inquiry
Evaluating responses
Listening techniques
Observing behavioral cues
©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 11 - 33
End of Chapter 11
Top Related