Detecting Fraud

Question 1

What are the auditor’s objectives to Detecting Fraud?

Answer 1

1 Identify and assess the risks of material misstatement due to fraud
2 Obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud
3 Respond appropriately to fraud or suspected fraud identified during the audit

Question 2

What is Fraud?

Answer 2

An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception that results in a misstatement in the financial statements

Question 3

What are Fraud Risk Factors?

Answer 3

Events or conditions that indicate (a) an incentive or pressure to perpetrate fraud; (b) provide an opportunity to commit fraud; or (c) indicate attitudes or rationalizations to justify a fraudulent action

Question 4

What are the 2 types of misstatements that are relevant to the auditor’s consideration of fraud?

Answer 4

1 Fraudulent financial reporting

2 Misappropriation of assets

Question 5

What is Fraudulent financial reporting?

Answer 5

involves misstatements that are intended to deceive financial statement users (e.g., the intent is to inflate the entity’s stock price)

Question 6

How does Fraudulent financial reporting take place?

Answer 6

It takes place when management has the ability to override control, recording of fictitious journal entries, concealing of facts, and altering underlying records to achieve the deception

Question 7

What is Misappropriation of assets?

Answer 7

Theft of assets causing the financial statements to be misstated owing to false entries intended to conceal the theft

Question 8

What are examples of Misappropriation of assets?

Answer 8

Embezzlement of receipts, stealing physical assets or intellectual property, and diverting the entity’s assets for personal use

Question 9

What is the basic responsibility an auditor has to designing (planning) the audit?

Answer 9

To provide “reasonable assurance” of detecting misstatements that are material to the financial statements

Question 10

What two levels should be performed with a risk assessment?

Answer 10

The risk assessment should be performed at both the financial statement level and the assertion level

Question 11

To obtain information needed to identify the risks of material fraud the auditor emphasizes what two procedures?

Answer 11

1 Inquiry

2 Analytical procedures

Question 12

What is Inquiry?

Answer 12

The auditor should question management personnel about their knowledge of fraud, suspected fraud, or allegations of fraud; inquire about specific controls that management has implemented to mitigate fraud risks; and inquire about management’s communications with those charged with governance about fraud-related issues

Question 13

Which account is particularly important in Analytical Procedures?

Answer 13

Revenue Accounts

Question 14

What are the 3 characteristics generally associated with fraud?

Answer 14

1 Incentive/pressure
2 Opportunity
3 Attitude/rationalization

Question 15

What are the reasons that management might be motivated to commit fraudulent financial reporting in regards to Incentive/pressure?

Answer 15

1 Financial stability/profitability

2 Excessive pressure to meet the expectations of outsiders

Question 16

What are samples of Financial stability/profitability?

Answer 16

operating losses threaten bankruptcy; there is vulnerability to rapid changes due to technology or other factors; there are increasing business failures in the industry; or the entity reports unusual profitability relative to others in the industry

Question 17

What are samples Excessive pressure to meet the expectations of outsiders?

Answer 17

the entity is only barely able to meet the stock exchange’s listing requirements; the entity is having difficulty meeting debt covenants; or the entity must obtain additional outside financing to retool production to be competitive

Question 18

What are the reasons that management might be motivated to commit fraudulent financial reporting in regards to Opportunities?

Answer 18

1 Nature of the industry or the entity’s operations
2 Ineffective monitoring of management
3 Complex or unstable organizational structure
4 Internal controls are deficient

Question 19

What are samples of Nature of the industry or the entity’s operations?

Answer 19

significant related-party transactions not in the ordinary course of business; ability to dominate suppliers or customers in a certain industry sector; unnecessarily complex transactions close to year-end raise “substance over form” issues; major financial statement elements that involve significant estimates by management that are difficult to corroborate

Question 20

What are samples of Ineffective monitoring of management?

Answer 20

domination of management by a single person or small group without compensating controls or; ineffective oversight by those charged with governance

Question 21

What are samples of Complex or unstable organizational structure?

Answer 21

organization consists of unusual legal entities; high turnover of senior management, counsel, or board members

Question 22

What are samples that Internal controls are deficient?

Answer 22

inadequate monitoring of controls; high turnover rates in accounting, internal auditing, and information technology staff; ineffective accounting and information systems

Question 23

What are the reasons that management might be motivated to commit fraudulent financial reporting in regards to Attitudes/Rationalizations?

Answer 23

1 Lack of commitment to establishing and enforcing ethical standards
2 Previous violations of securities laws (or other regulations)
3 Excessive focus by management on the entity’s stock price
4 Management’s failure to correct reportable conditions
5 Pattern of justifying inappropriate accounting as immaterial
6 Management has a strained relationship with the predecessor or current auditor