Transcript Chapter 11 – Fraud Auditing

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
1. Incentives/Pressures
Financial stability or profitability is threatened by
economic, industry, or entity operating conditions.
Excessive pressure exists for management
to meet debt requirements / EPS / budgets – Waste Mgt
Personal net worth of mgt is materially threatened.
Stock price obsession - Worldcom
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Examples of Risks Factors
for Fraudulent Reporting
2. Opportunities
There are significant accounting estimates
that are difficult to verify – Waste Mgt.
There is ineffective oversight over
financial reporting – less collusion needed: Enron.
Ineffective internal audit, internal controls,
or information technology staff exists: ERP systems
CA and bolt on applications
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Examples of Risks Factors
for Fraudulent Reporting
3. Attitudes/Rationalization
Inappropriate or inefficient communication
and support of the entity’s values is evident.
SOX – code of ethics – Tone from the top.
A history of violations of laws is known.
Management has a practice of making overly
aggressive or unrealistic forecasts.
W & K’s Broken Window Theory
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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 Risk
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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Learning Objective 4
What does the latest research tell us?????
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Research
1. Auditors are typically good at FR assessment
2. Auditors could use NFMs to better assess FR
3. Auditors typically bad at responding to FR – testing
4. Brainstorming (???) is “good”, Group Support
Systems may improve bstorming, and bstorming
improves “nature” reaction – let’s bstorm about
potential “nature” reactions.
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Changing Nature
A/P - More reliable expectations, more
detailed level
Confirmations - Add sales agreement info
or have oral discussions with customers
CAATs – search for unusual entries,
names, related parties
Inquiry - Talk to nonfinancial personnel
More physical observation / external
evidence vs. tracing to IT/system data
FV – specialist estimate and compare vs.
auditing mgt’s estimate
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Tell me about the avg bstorm
session
Partner/CFE led (60%), not all members
(27%), fraud specialist (31%-only led 4/56),
IT/Tax (69/63%), hierarchical participation,
use of checklist (72%), held late (35%), no
wrap-up in PY (84%), average total time (1.5
hours), more than one session (50%).
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Distribution of Bstorming Quality
Partner/CFE led (60%), not all members
(27%), fraud specialist (31%-only led
4/56), IT/Tax (69/63%), hierarchical
participation, use of checklist (72%), held
late (35%), no wrap-up in PY (84%),
average total time (1.5 hours), more than
one session (50%).
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Brainstorming Session Quality Score
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Distribution of FR Assessments
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Does Bstorming Quality
Matter??
Brainstorming
Quality
FR
Factors
FR
Assessment
FR
Responses
Best practices – ptr led, IT auditor present, held
early, MC, PC, Discussion of FR factors and
responses
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Other Findings from Research
1. Red Flags – Insiders on BOD, High Accruals, Stock
Options (evidence is mixed), highly leveraged, younger
Companies, M&A activity, and Rev Growth
2. Investors hold SEC and External auditors most
accountable for detecting fraud
3. Auditor litigation all about overstated Rev and Assets
fraudulent financial reporting
4. Fraud Experiences – 1989: avg .5 frauds for career
2007: avg 71% at least one, 21% at least 2, why?
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