11 - 1 ©2006 prentice hall business publishing, auditing 11/e, arens/beasley/elder fraud auditing...

11 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder

Fraud AuditingFraud Auditing

Chapter 11Chapter 11


Learning Objective 1Learning Objective 1

Define fraud and distinguishDefine fraud and distinguish

between fraudulent financialbetween fraudulent financial

reporting and misappropriationreporting and misappropriation

of assets.of assets.


Types of FraudTypes of Fraud

Fraudulent financial reportingFraudulent financial reporting

Misappropriation of assetsMisappropriation of assets



Describe the fraud triangle andDescribe the fraud triangle and

identify conditions for fraud.identify conditions for fraud.


The Fraud TriangleThe Fraud Triangle

Incentives/PressuresIncentives/Pressures

OpportunitiesOpportunities Attitudes/RationalizationAttitudes/Rationalization


Examples of Risks Factors for Examples of Risks Factors for Fraudulent ReportingFraudulent Reporting

Financial stability or profitability is threatened byFinancial stability or profitability is threatened byeconomic, industry, or entity operating conditions.economic, industry, or entity operating conditions.

Excessive pressure exists for management toExcessive pressure exists for management tomeet debt requirements.meet debt requirements.

Personal net worth is materially threatened.Personal net worth is materially threatened.



There are significant accounting estimates thatThere are significant accounting estimates thatare difficult to verify.are difficult to verify.

There is ineffective oversight over financialThere is ineffective oversight over financialreporting.reporting.

High turnover or ineffective accounting internalHigh turnover or ineffective accounting internalaudit, or information technology staff exists.audit, or information technology staff exists.



Inappropriate or inefficient communicationInappropriate or inefficient communicationand support of the entity’s values is evident.and support of the entity’s values is evident.

A history of violations of laws is known.A history of violations of laws is known.

Management has a practice of makingManagement has a practice of makingoverly aggressive or unrealistic forecasts.overly aggressive or unrealistic forecasts.


Examples of Risks Factors for Examples of Risks Factors for Misappropriation of AssetsMisappropriation of Assets

Personal financial obligations create pressure toPersonal financial obligations create pressure tomisappropriate assets.misappropriate assets.

Adverse relationships between managementAdverse relationships between managementand employees motivate employees toand employees motivate employees tomisappropriate assets.misappropriate assets.



There is a presence of large amounts of cashThere is a presence of large amounts of cashon hand or inventory items.on hand or inventory items.

There is an inadequate internal control overThere is an inadequate internal control overassets.assets.



Disregard for the need to monitor or reduceDisregard for the need to monitor or reducerisk of misappropriating assets exists.risk of misappropriating assets exists.

There is a disregard for internal controls.There is a disregard for internal controls.



Understand the auditor’sUnderstand the auditor’s

responsibility for assessingresponsibility for assessing

the risk of fraud and detectingthe risk of fraud and detecting

material misstatements due tomaterial misstatements due to

fraud.fraud.


Assessing the Risk of FraudAssessing the Risk of Fraud

SAS 99 provides guidance to auditorsSAS 99 provides guidance to auditorsin assessing the risk of fraud.in assessing the risk of fraud.


Professional SkepticismProfessional Skepticism

SAS 1 states that, in exercising professionalSAS 1 states that, in exercising professionalskepticism, an auditor “skepticism, an auditor “neither assumes thatneither assumes thatmanagement is dishonest nor assumesmanagement is dishonest nor assumesunquestionedunquestioned honestyhonesty..””


Sources of Information Gathered Sources of Information Gathered to Assess Fraud Risksto Assess Fraud Risks

CommunicationCommunicationamong audit teamamong audit team

Inquiries ofInquiries ofmanagementmanagement

RiskRiskfactorsfactors

AnalyticalAnalyticalproceduresprocedures

OtherOtherinformationinformation

Identified risks of material misstatements due to fraudIdentified risks of material misstatements due to fraud


Documenting Fraud AssessmentDocumenting Fraud Assessment

DiscussionDiscussion

Specific risksSpecific risks

ProceduresProcedures

ReasonsReasons

ResultsResults Other conditionsOther conditions

Nature of communicationsNature of communications



Identify corporate governanceIdentify corporate governance

and other control environmentand other control environment

factors that reduce fraud risks.factors that reduce fraud risks.


Corporate Governance OversightCorporate Governance Oversightto Reduce Fraud Risksto Reduce Fraud Risks

1. Create and maintain a culture of honesty1. Create and maintain a culture of honesty and high ethics.and high ethics.

2. Evaluate fraud risks and implement programs2. Evaluate fraud risks and implement programs and controls to mitigate identified fraud risks.and controls to mitigate identified fraud risks.

3. Develop an appropriate fraud oversight process.3. Develop an appropriate fraud oversight process.


Example Elements for a Code of Example Elements for a Code of ConductConduct

Organizational code of conductOrganizational code of conduct

General employee conductGeneral employee conduct

Conflicts of interestConflicts of interest

Outside activities, employment, and directorshipsOutside activities, employment, and directorships



Relationships with clients and suppliersRelationships with clients and suppliers

Gifts, entertainment, and favorsGifts, entertainment, and favors

Kickbacks and secret commissionsKickbacks and secret commissions

Organization funds and other assetsOrganization funds and other assets



Organization records and communicationsOrganization records and communications

Dealing with outside people and organizationsDealing with outside people and organizations

Prompt communicationsPrompt communications

Privacy and confidentialityPrivacy and confidentiality


Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud

20032003 19981998 19941994

Collusion betweenCollusion betweenemployees andemployees and

third partiesthird parties

InadequateInadequateinternalinternalcontrolscontrols

ManagementManagementoverride ofoverride of

internal controlsinternal controls

484831313333

393958585959

313136363636


Organizational Factors Organizational Factors Contributing to Risk of FraudContributing to Risk of Fraud

Collusion betweenCollusion betweenemployees andemployees and

managementmanagement

Lack of controlLack of controlover managementover management

be directorsbe directors

Ineffective orIneffective ornonexistent ethics ornonexistent ethics orcompliance programcompliance program

151519192323

12121111 66

1010 88 77

20032003 19981998 19941994



Develop responses to identifiedDevelop responses to identified

fraud risks.fraud risks.


Responding to the Risk of FraudResponding to the Risk of Fraud

Change the overall conduct of the auditChange the overall conduct of the auditto respond to identified fraud risks.to respond to identified fraud risks.

Design and perform audit proceduresDesign and perform audit proceduresto address identified risks.to address identified risks.

Design and perform procedures toDesign and perform procedures toaddress the risk of managementaddress the risk of managementoverride of controls.override of controls.



Recognize specific fraud riskRecognize specific fraud risk

areas and develop proceduresareas and develop procedures

to detect fraud.to detect fraud.


Rates of Fraud OccurrenceRates of Fraud Occurrence

20032003 19981998

Theft of assetsTheft of assets 49492222

Check fraudCheck fraud 40402626

Expense accountExpense accountabuseabuse

36361313

Credit card fraudCredit card fraud 20201313

Payroll fraudPayroll fraud 1212 33


Rates of Fraud OccurrenceRates of Fraud Occurrence

20032003 19981998

Conflict of interestConflict of interest 1212 99

Inventory theftInventory theft 11111111

KickbacksKickbacks 99 66

Financial reportingFinancial reportingfraudfraud

77 33


Specific Fraud Risk AreasSpecific Fraud Risk Areas

Inventory fraud risksInventory fraud risks

Revenue and accounts receivable fraud risksRevenue and accounts receivable fraud risks

Purchases and accounts payable fraud risksPurchases and accounts payable fraud risks

Other areas of fraud riskOther areas of fraud risk



Understand interview techniquesUnderstand interview techniques

and other activities after fraudand other activities after fraud

is suspected.is suspected.


Methods of Uncovering FraudMethods of Uncovering Fraud

20032003 19981998 19941994

Internal controlsInternal controls

Internal auditInternal audit

NotificationNotificationby employeeby employee

77%77%51%51%52%52%

65%65%43%43%47%47%

63%63%58%58%51%51%



20032003 19981998 19941994

AccidentAccident

Anonymous tipAnonymous tip

NotificationNotificationby customerby customer

54%54%37%37%28%28%

41%41%35%35%26%26%

34%34%41%41%34%34%



20032003 19981998 19941994

Notification byNotification byregulatory or lawregulatory or law

enforcement agencyenforcement agency

NotificationNotificationby vendorby vendor

External auditExternal audit

19%19%16%16% 8%8%

16%16%11%11%15%15%

12%12% 4%4% 5%5%


Responding to Misstatements that Responding to Misstatements that May be the Result of FraudMay be the Result of Fraud

When fraud is suspected,When fraud is suspected,the auditor gathersthe auditor gathersadditional informationadditional informationto determine whetherto determine whetherfraud actually exists.fraud actually exists.


Types of Inquiry TechniquesTypes of Inquiry Techniques

Informational inquiryInformational inquiry

Assessment inquiryAssessment inquiry

Interrogative inquiryInterrogative inquiry


Types of Inquiry TechniquesTypes of Inquiry Techniques

Evaluating responsesEvaluating responses

Listening techniquesListening techniques

Observing behavioral cuesObserving behavioral cues


End of Chapter 11End of Chapter 11

11 - 1 ©2006 prentice hall business publishing, auditing 11/e, arens/beasley/elder fraud auditing...

Documents