2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

5 - 5
Fraud Auditing
Chapter 11
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 2
Learning Objective 1
Define fraud and distinguish between
fraudulent financial reporting and
misappropriation of assets.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 3
Types of Fraud
Fraudulent
financial
reporting
Misappropriation
of assets
Management
Fraud
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 4
Learning Objective 2
Describe the fraud triangle and identify
conditions for fraud.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 5
The Fraud Triangle
Incentives/Pressures
Opportunities Attitudes/Rationalization
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 6
Why Fraud Occurs
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 7
Examples of Risk Factors
for Fraudulent Reporting
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
Incentives/Pressures:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 8
Examples of Risk Factors
for Fraudulent Reporting
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
Opportunities:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 9
Examples of Risk Factors
for Fraudulent Reporting
Inappropriate or inefficient communication
and support of the entitys values is evident
A history of violations of laws is known
Management has a practice of making
overly aggressive or unrealistic forecasts
Attitudes/Rationalization:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 10
Examples of Risk Factors
for Misappropriation of Assets
Personal financial obligations create pressure
to misappropriate assets
Adverse relationships between management
and employees motivate employees to
misappropriate assets
Incentives/Pressures:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 11
Examples of Risk Factors
for Misappropriation of Assets
There is a presence of large amounts of cash
on hand or inventory items
There is an inadequate internal control over
assets
Opportunities:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 12
Examples of Risk Factors
for Misappropriation of Assets
Disregard for the need to monitor or reduce
risk of misappropriating assets exists
There is a disregard for internal controls
Attitudes/Rationalization:
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 13
Learning Objective 3
Understand the auditors responsibility for
assessing the risk of fraud and detecting
material misstatements due to fraud.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 14
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 15
Sources of Information Gathered
to Assess Fraud Risks
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 16
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

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 17
Learning Objective 4
Identify corporate governance and other
control environment factors that reduce
fraud risks.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 18
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 19
Example Elements for a Code of
Conduct
Organizational code of conduct

General employee conduct

Conflicts of interest

Outside activities, employment, and
directorships
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 20
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 21
Example Elements for a Code of
Conduct
Organization records and communications

Dealing with outside people and
organizations

Prompt communications

Privacy and confidentiality
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 22
Organizational Factors
Contributing to Risk of Fraud
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 23
Learning Objective 5
Develop responses to identified fraud risks.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 24
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 25
Learning Objective 6
Recognize specific fraud risk areas and
develop procedures to detect fraud.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 26
Specific Fraud Risk Areas
Inventory fraud risks
Revenue and accounts receivable fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 27
Effect of Fictitious Receivables
on Accounting Ratios
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 28
Effect of Fictitious Inventory on
Inventory Turnover
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 29
Learning Objective 7
Understand interview techniques and other
activities after fraud is suspected.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 30
Responding to Misstatements That
May Be the Result of Fraud
When fraud is suspected, the auditor gathers
additional information to determine whether
fraud actually exists.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 31
Initial Detection Method for Million-Dollar
Schemes
Tip
By Accident
Internal Audit
Internal Controls
External Audit
Notified By Police
$1,000,000
+
All Cases
0% 10% 20% 30% 40% 50%
Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.
42.3%
46.2%
22.8%
20.0%
18.6%
19.4%
16.7
% 23.3%
15.8%
9.1
%
6.0%
3.2%
T
y
p
e

o
f

D
e
t
e
c
t
i
o
n

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 32
Types of Inquiry Techniques
Informational
Assessment
Interrogative
Evaluating
responses
Listening
Observing
behavioral cues
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 33
Observing Verbal Cues
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 11 - 34
Observing Non-Verbal Cues
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 5
End of Chapter 11