Exam 3 - Chapter 11 - Fraud Auditing Flashcards
What are the two types of fraud relevant to auditing?
- Fraudulent financial reporting
Intentional misstatement/ommision of amounts or disclosures with intent to deceive
- Miasppropriation of Assets
Fraud that involves theft of entity’s assets
What is income smoothing?
- Type of earnings management (fraudulent reporting of earnings)
management creates “cookie reserve” of earnings by witholding revenue/expenses of current period for use in a future period
What is the fraud triangle?
Three conditions that increase the chance for fraud to have occured:
- Incentives/Pressures: MGMT and employees have incentives to commit fraud
- Opportunities: Circumstances that allow MGMT/emp to commit fraud (lacking Int Controls)
- Attitudes/Rationalization: Character/ethical values of MGMT & Quality of working environment
What guidance do auditing standards provide on assessing the risk of fraud?
- Auditors are to maintain professional skepticism - Auditors are to neither assume dishonest/honesty of management
- Auditors should maintain a questioning mind - Auditors are to consider every company’s susceptibility of fraud
What are the 5 sources of information for assessing fraud risk?
- Communications among audit team
- Inquiries of management
- Risk factors
- Analytical Procedures
- Other suspicious knowledge (mangement’s integrity, etc…)
Communications among audit teams for assessing fraud
- Why is it important to audits
- What items should be discussed?
Auditing standards require discussions to share insights from audit team members
discussions should include:
- How/where entity’s financials might be fraudulent
- How management could perpetrate and conceal fraud
- How anyone might misappropriate assets
- How auditors should respond to susceptibility of fraud
What are inquiries of management for assessing fraud risk?
Procedure required by auditing standards:
auditors are to inquire from management and non-financial reporting staff (purchasing agents, warehouse managers) about risks of fraud
How do analytical procedures help assess fraudulent financial reporting?
Auditors can use analytical procedures from planning phase to assess unusual changes observed from:
- Ratio analysis
- Horizontal analysis
- Vertical analysis
Auditing standards require auditors to document fraud assessment.
What must be included in these documents?
- Discussion among engagement team
- Procedures performed to assess risk
- Results of procedures performed
- Specific risks and audit response
- Reasons supporting conclusions
- Other conditions and analytical relationships
- Nature of communications made to entity
What is the importance of corporate governance in reducing fraud risk?
Management is responsible for implementing corporate governance to prevent, deter, and detect fraud:
- Culture and honesty and high ethics
- Management’s responsibility to evaluate risks of fraud
- Audit committee oversight
How can management ensure corporate governance has culture of honesty and high ethical standards?
- Create a positive work environment
- Establish and follow code of conduct
- Hire/promote appropriate employees
- Training
- Confirmation (check with employees that they understand protocol)
- Discipline of accountable employees
What are some actions management can take to ensure their (management’s) responsibility to evaluate risks of fraud?
- Identifying and measuring fraud risks
- Mitigating fraud risks: design and implement programs and control
- Monitoring fraud prevention programs and controls: often through the aid of the internal audit department
What are the top 5 organizational factors that contribute to risk of fraud
- management should be on the lookout for these
- Inadequate internal controls
- Management override of int. controls
- Inadequate oversight by directors over management
- Collusion between employees/third party
- Collusion between employees and management
What is the audit committee:
Organized, outside party required for public companies that oversees:
- the organizations financial reporting
- internal control processes
- assesses fraud risk of management (deterrent for managemet fraud)
Explain interactions between the auditors, audit committee, and internal audit.
- The audit team is required (PCAOB standard 5) to evaluate effectiveness of audit committee.
- Audit committee should effectively oversee interactions and financial reporting
