Fraud Auditing

Chapter 11

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

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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

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Types of Fraud
Management
Fraud

Fraudulent
financial
reporting

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

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

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

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Why Fraud Occurs

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Examples of Risk Factors

for Fraudulent Reporting
Incentives/Pressures:

Financial stability or profitability is threatened b

economic, industry, or entity operating conditio
Excessive pressure exists for management to
meet debt requirements
Personal net worth is materially threatened

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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, interna

audit, or information technology staff exists
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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

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

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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

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

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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

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

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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

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

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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

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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.

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

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Sources of Information Gathered

to Assess Fraud Risks

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

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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

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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

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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

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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

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

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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

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

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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

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

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Organizational Factors
Contributing to Risk of Fraud

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Learning Objective 5
Develop responses to identified fraud
risks.

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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 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

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

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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

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Effect of Fictitious
Receivables on Accounting
Ratios

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

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Effect of Fictitious Inventory

on Inventory Turnover

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

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

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

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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.

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

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Initial Detection Method for Million-Dollar

Schemes
42.3%

Type of Detection

Tip

46.2%
22.8%

By Accident

20.0%

18.6%
19.4%

Internal Audit

16.7
%
23.3%

Internal Controls

15.8
9.1 %
%
6.0%
3.2
%

External Audit
Notified By Police
0%

$1,000,00
0+
All
Cases

30
40%
50
%
%
Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one
10%

20%

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

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Types of Inquiry Techniques

Informational
Assessment
Listening

Evaluating
responses

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

Interrogative

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Observing Verbal Cues

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Observing Non-Verbal Cues

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End of Chapter 11

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

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