Chapter 4: Management Fraud and Audit Risk Flashcards
Define audit risk
The probability an audit team will express an inappropriate audit opinion when the financial statements are materially misstated
Overall risk components
1) Inherent risk
2) Control risk
3) Detection risk
Define Risk of Material Misstatement (RMM)
The risk a material misstatement exists in the financial statements before auditors apply their own procedures
Define Inherent Risk
The probability that, in the presence of internal controls, material errors or frauds could enter the accounting system used to develop financial statements
Define Control Risk
The probability that the client’s internal control activities will fail to prevent or detect material misstatements provided that such misstatements enter or would have entered the accounting system in the first place
Define Detection Risk
The probability that the auditor’s own procedures will fail to detect material misstatements provided that any have entered the accounting system in the first place and have not been prevented or detected and corrected by the client’s internal controls
What is the audit risk model? (Equation)
Audit Risk (AR) = Inherent Risk (IR) x Control Risk (CR) x Detection Risk (DR)
Define what the nature of an audit procedure refers to
Nature - refers to the type of procedures
Define what the timing of an audit procedure refers to
Timing - refers to when the audit procedures will be completed
Define what the extent of an audit procedure refers to
Extent - refers to the number of tests performed
Define fraud
The act of knowingly making material misrepresentations of fact with the intent of inducing someone to believe the falsehood and act on it and, thus, suffer a loss or damage
Name the 3 most common ways in which companies misstate financial information
1) Overstating revenues and assets
2) Understating expenses and liabilities
3) Giving disclosures that are misstated or that omit important information
Name the 2 different types of fraud
1) Fraudulent financial reporting (A.K.A. management fraud)
2) Misappropriation of assets (A.K.A. employee fraud)
How can owners/managers commit fraud?
a) Insider trading
b) related-party transactions
How can customers commit fraud?
a) shoplifting
b) false refunds
c) false credit cards
d) NSF checks
How can owners/managers commit fraud against customers?
a) false advertising
b) short shipments
c) defective products
d) price fixing
How can companies commit fraud against the government?
a) tax evasion
b) contract cost padding
c) false benefit claims
