Fraud Auditing

Chapter 11

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 1
Define fraud and distinguish
between fraudulent financial
reporting and misappropriation
of assets.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Types of Fraud
Fraudulent financial reporting
Misappropriation of assets

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 2
Describe the fraud triangle and
identify conditions for fraud.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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The Fraud Triangle

Incentives/Pressures

Opportunities

Attitudes/Rationalization

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Examples of Risk Factors

for Fraudulent Reporting
Attitudes/Rationalization:
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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 3
Understand the auditors
responsibility for assessing
the risk of fraud and detecting
material misstatements due to
fraud.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Sources of Information Gathered

to Assess Fraud Risks
Communication
among audit team

Inquiries of
management

Risk
factors

Analytical
procedures

Other
information

Identified risks of material misstatements due to fraud

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Documenting Fraud
Assessment
Discussion
Procedures
Specific risks
Reasons
Other conditions
Results
Nature of communications
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 4
Identify corporate governance
and other control environment
factors that reduce fraud risks.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Organizational Factors
Contributing to Risk of Fraud
Collusion between
employees and
third parties
Inadequate
internal
controls
Management
override of
internal controls
2003

1998

48
31
33
39
58
59
31
36
36
1994

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Organizational Factors
Contributing to Risk of Fraud
Collusion between
employees and
management
Lack of control
over management
by directors
Ineffective or
nonexistent ethics or
compliance program
2003

1998

15
19
23
12
11
6
10
8
7
1994

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 5
Develop responses to identified
fraud risks.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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 identified risks.
Design and perform procedures to
address the risk of management
override of controls.
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 6
Recognize specific fraud risk
areas and develop procedures
to detect fraud.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Rates of Fraud Occurrence

Theft of assets

49
22

Check fraud

40
26

Expense account
abuse

36
13

Credit card fraud

20
13

Payroll fraud

12
3

2003

1998

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Rates of Fraud Occurrence

Conflict of interest

12
9

Inventory theft

11
11

Kickbacks

9
6

Financial reporting
fraud

7
3

2003

1998

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Specific Fraud Risk Areas

Revenue and accounts receivable fraud risks
Inventory fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 7
Understand interview techniques
and other activities after fraud
is suspected.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Methods of Uncovering Fraud

(Percentages)
Internal controls
Internal audit
Notification by employee
Accident
Anonymous tip
Notification by customer
Notification by regulatory or
law enforcement agency
Notification by vendor
External audit
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

2003 1998 1994

77
65
63
54
41
34
19

51
43
58
37
35
41
16

52
47
51
28
26
34
8

16
12

11
4

15
5
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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Types of Inquiry Techniques

Informational inquiry
Assessment inquiry
Interrogative inquiry
Evaluating responses
Listening techniques
Observing behavioral cues
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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End of Chapter 11

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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