Fraud

Question 1

What are fraud risk factors?

Answer 1

They represent factors/conditions that are generally present in fraud:

Incentives/Pressure

Rationalization

Opportunity

Example - Excessive cash on hand can be a factor because the cash could be at risk for being misappropriated (theft) or defalcation.

Keep in mind that fraud risk factors represent only potential fraud.

Question 2

What areas of fraud risk factors should the auditor pay attention to?

Answer 2

The auditor should pay special attention to fraud risk factors that increase the probability of fraudulent reporting or defalcation because they could result in material misstatement.

NOTE: The auditor’s objective is to provide reasonable assurance on whether the financial statements are free of material misstatments, whether due to fraud or error.

Question 3

When should the auditor perform audit tests that are specifically designed to detect fraud and what are the reasons for the timing of these audit tests?

Answer 3

The auditor should perfom the audit tests that are specifically designed to detect fraud while planning the engagement.

The reason for performing these tests at the planning stage is to give as much informaiton to the auditor in order to decide whether to proceed with the audit or withdraw; or if proceed with the audit, adjust how the audit would be conducted to better address evidence of fraud risk.

Question 4

What audit tests can the auditor use to detect fraud?

Answer 4

Inquiries to management and other key personnel about risk of fraud and whether they are aware of any fraud within the entity; to audit committee; and to internal auditors

Unpredictable tests on a low-risk area

Analytical procedures to identify unsual relationships and consider their effect on the upcoming fieldwork phase

Identifying fraud risk factors by noting conditions that could involve incentives/pressures, opportunity, and rationalization for perpeturating fraud.

Question 5

What are examples of misstatements?

Answer 5

Differences between amount, calssification, or presentation as reported and what would have been reported under GAAP

Omissions of financial statement items

Disclosures not conforming to GAAP

Omitting informaiton from required GAAP disclsoures

Question 6

How can misstatements be evaluated? Give examples?

Answer 6

**Quantitatively and Qualitatively **

Examples:

• Trends of profitability
• Changing loss into income
• Affecting segment information
• Compliance with legal or contractual requirements

Question 7

What are the sources of material misstatements in financial statements?

Answer 7

Errors and Fraud

Question 8

Define “error” versus “fraud”

Answer 8

Errors = unintentional mistakes, misjudgments or omissions of amounts or disclosures, incompetency

Fraud = intentional acts of misrepresenting facts in financial statements (fraudulent financial reporting) and/or misappropriation of assets (defalcation, embezzlement, stealing, theft = direct illegal acts)

Question 9

What misstatements must be communicated by the auditor and how should they be communicated?

Answer 9

ALL known and likely misstatements (even immaterial) other than those that the auditor considers to be trivial

Communicate to the *appropraite level of management. *

NOTE: Management is responsible for the preparation and fair presentation of the client’s financial statements in conformity with GAAP. Therefore, management must correct all known misstatements and evaluate items for likely misstatements.

Question 10

What steps does the auditor take in order to meet its responsibibilities fro considering fraud in a financial statement audit?

Answer 10

Understand nature and characterisitcs of fraud

Discuss risk of fraud with engagement staff

Obtain information to identify risks of fraud

Identify risks that may cause material misstatement due to fraud and Assess these risks

Adjust the audit program

Evaluate audit evidence

Communicate about fraud to managment & audit committee (those charged with Governance)

Document auditor’s consideration of fraud

Question 11

What factors does the auditor need to consider when identifying risks for material misstatements due to fraud?

Answer 11

Frauds like to say to auditors: “Try My Luck, PaL”

Type of fraud (fraudulent financial reporting or missapropriation of assets?)

Magnitude (materiality)

Likelihood and Level of management involved

Pervasiveness of risk (One account or the entire F/S?)

Question 12

An auditor has identified risks that may result in material misstatement due to fraud, how should the auditor assess these risks?

Answer 12

Evaluate whether the client’s programs and controls related to the risks are suitably designed and placed in operation.

If these programs/controls are not in operation, then the auditor need to focus even more on that area during the engagement.

Question 13

When should the auditor evaluate audit evidence obtained from audit tests performed for detecting fraud

Answer 13

At or near the completion of fieldwork.

Question 14

If an auditor beleives there are misstatements caused by fraud, but cannot determine the materiality, then what should the auditor do?

Answer 14

Attempt to obtain audit evidence

Consider implications from other aspects of the audit

Discuss the matter with an appropriate level of management at least ONE level above those involved and with senior management¹ and the audit committee

Consult with legal counsel

¹If senior management is suspected of fraud, then report directly to audit committee.

Question 15

When senior management has found to have engaged in a fraud scheme, who should the auditor addres the matter to?

What about non-senior management personnel?

Answer 15

Senior management = Directly to the audit committee

Non-senior management = at least ONE level above those involved, senior management, and audit committee

(DISAPPROVE)

Question 16

Under what circumstances may the auditor consider withdrawing?

Answer 16

Implications about management’s integrity

Lack of due diligence and cooperation from management or board of directors.

Implications = a likely consequence of something

Question 17

What presumption is ALWAYS a fraud risk?

Answer 17

Improper revenue recognition

Question 18

What must always be addressed by the auditor in conjunction with the pervasiveness of risk that may result in material misstatement due to fraud?

Answer 18

Management override of controls

Question 19

What would an audit team do when discussing risk of fraud?

Answer 19

Brainstorm about:

How and where in the F/S that might be suspectible to fraud

How management could perpetrate and conceal fraudulent F/S (management override of controls)

fraud risk factors (incentives/pressures, opportunities, rationalization)

Question 20

An auditor’s assessment indicates risks for fraud, how should the auditor respond?

Answer 20

Adjust the audit program in three ways:

Change the overall manner in which the audit is conducted (pay more attention to areas that lack or have weak controls)

Change NTE of substantive tests (since can’t Rely on controls)

Performing procedures specifically designed to uncover management override of controls¹

¹Recall that the auditor must to consider how pervasive the RMM due to fraud and must look at risk for managment override of control.

Question 21

What illegal acts is the auditor limited to discovering?

Answer 21

Limited to illegal acts that have direct and material effect on the financial statements (same as for errors and fraud) resulting in adjusting entries

Question 22

What are examples of illegal indirect acts?

Answer 22

• Insider trading
• Illegal bribes
• Violations of OSHA and antitrust laws
• Price-fixing

Question 23

What are examples of illegal direct acts?

Answer 23

• embezzlement of funds
• violations of tax lawas
• accruing improper amounts against government regulations

Question 24

When is the auditor required to disclose of fraud beyond senior management and its audit committee?

Answer 24

Specific legal and regulatory requirements (SEC)

To a successor auditor

Valid subpoena or court order

To a funding agency in which the client receives governmental financial assistance

Question 25

When the client refuses or does not follow through with the auditor’s proposed adjustment to correct material misstatements, what opinion would the auditor express in the report?

Answer 25

Qualified or Adverse opinion on the F/S due to the departure from GAAP.

Question 26

If the auditor is unable to obtain sufficient appropriate audit evidence to determine whether errors or fraud have material effects on the F/S, then what kind of opinion can the auditor render?

Answer 26

Qualified or Disclaim due to socpe limitation

Question 27

Under what standards does a CPA firm use as the framework for establishing a system of quality control and for which type of services?

Answer 27

Statements on Quality Control Standards (SQCS), issued by ASB, for auditing, accounting and review services.

Question 28

Which of the following need not be documented in relation to an auditor’s consideration of fraud?

• Nature of communications of fraud made to management
• Procedures performed to obtain information to identify and assess risks of material misstatement due to fraud
• The assessed level of risk of management override of controls
• Specific risks of material misstatement due to fraud that were identified.

Answer 28

The assessed level of risk of management override of controls

b/c we always know that management override of controls is inherent in any entity (COCO). We will always add it as a risk factor, but we do not have to do an assessment on the level of risk of management override. It is a given, so therefore we don’t need to document it.