ISA 240 Fraud overview and Planning

Question 1

1. What are the responsibilities of management in fraud prevention?

Answer 1

1. Creating a culture of honesty and ethical behavior
2. Strong emphasis on fraud prevention
3. Considering the potential for override of control

Question 2

2. What are the responsibilities of auditors regarding fraud?

Answer 2

1. Maintain professional skepticism
2. Engage in team discussions
3. Identify and assess the Risk of Material Misstatement (ROMM)
4. Respond to those risks by performing audit procedures to obtain Sufficient Appropriate Audit Evidence (SAAE)
5. Respond if circumstances indicate the possibility of fraud

Question 3

3. What are the inherent limitations of fraud detection?

Answer 3

1. Fraud is properly planned and organized
2. Collusion may cause the auditor to believe that audit evidence is persuasive when it is false
3. Difficult to detect if senior management is involved

Question 4

4. Why must auditors maintain professional skepticism in fraud detection?

Answer 4

1. Consider the potential for override of control
2. Regardless of past experience and culture of honesty and integrity of management, auditors should maintain professional skepticism

Question 5

5. What should be discussed among the engagement team regarding fraud?

Answer 5

How the entity’s financial statements may be susceptible to material misstatement due to fraud

Question 6

6. What are the key risk assessment procedures and related activities for fraud detection?

Answer 6

1. Inquiry with Management
2. Inquiry with the Board of Directors
3. Inquiry with the Internal Auditor
4. Unusual or Unexpected Relationship Identified

Question 7

What is the procedure of Inquiry with Management for assessment of fraud.

Answer 7

1. Management’s process for identifying and responding to the risk of fraud
2. Management’s assessment of the risk that financial statements are materially misstated
3. Management’s communication to those charged with governance (TCWG) regarding fraud processes
4. Management’s communication to employees regarding business practices and ethical behavior

Question 8

How does Inquiry with the board of directors happen wrt fraud detection?

Answer 8

Understanding how TCWG exercises oversight over management’s process for identifying and responding to fraud risks

Question 9

How to inqure with internal auditor wrt fraud detection?

Answer 9

1. Whether they have knowledge of any actual, suspected, or alleged fraud affecting the entity
2. Their views about the risks of fraud

Question 10

What to do if any unusual or unexpected relationship is identified?

Answer 10

Perform preliminary analytical procedures to identify unusual or unexpected relationships

Question 11

What are the major fraud risk factors?

Answer 11

1. Fraudulent Financial Reporting
2. Misappropriation of Assets

Question 12

What circumstances lead to Fraudulent Financial Reporting?

Answer 12

1. Incentive or Pressure:
   a. High degree of competition
   b. Changes in technology
   c. Significant decline in customer demand
   d. Operating losses threatening bankruptcy or hostile takeover
   e. Rigid growth or unusual profitability
   f. Need to obtain additional financing
   g. Listing requirement or debt covenants
   h. Significant financial interest in entity
   i. Significant portion of their compensation being contingent upon achieving targets
2. Opportunities
   a. Transactions with related parties
   b. Many estimates involved
   c. Complex transactions
   d. Ineffective oversight by the Board of Directors
   e. High turnover of senior management
   f. Inadequate monitoring of control
3. Attitude / Rationalization

a. Communicating inappropriate ethical values
b. Management failed to remedy known deficiencies in internal control

Question 13

What circumstances lead to Misappropriation of Assets?

Answer 13

1. Incentive or Pressure
   a. Known or anticipated future layoffs
   b. Recent or anticipated changes to employee compensation
   c. Promotion or reward inconsistent with expectations
2. Opportunities
   a. Large amounts of cash
   b. Inventory items that are small in size but possess high value
   c. Easily convertible assets
   d. Fixed assets which are small in size
   e. Inadequate internal control over assets
3. Attitude / Rationalization
   a. Disregarding the need for monitoring or reducing the risk related to misappropriation of assets (MOA)

Question 14

7. What are the fraud risk factors in financial reporting?

Answer 14

Incentives: Competition, losses, financing needs
Opportunities: Related parties, complex transactions, weak oversight
Attitude: Poor ethics, ignoring internal control issues

Question 15

8. What are the fraud risk factors in asset misappropriation?

Answer 15

Incentives: Layoffs, unfair promotions
Opportunities: Small valuable assets, weak controls
Attitude: Ignoring monitoring needs

Question 16

What are the procedures against fraud risk at the financial statement level?

Answer 16

1. Assign and supervise personnel having knowledge, skill, and ability
2. Evaluate selection and application of accounting policy
3. Incorporate unpredictability in audit procedures

Question 17

2. Why is there a presumed significant risk due to fraud in revenue recognition?

Answer 17

1. Fraud risk in revenue recognition is presumed significant
2. Exception applies if the revenue recognition process is very simple

Question 18

Why is management override of control a significant fraud risk?

Answer 18

1. Management can manipulate records and override controls
2. Such manipulation can lead to fraudulent financial statements
3. Risk of material misstatement due to fraud

Question 19

What are the techniques used for management override of control?

Answer 19

1. Concealing or not disclosing facts affecting financial statements
2. Recording fictitious journal entries to manipulate operating results
3. Altering records and terms of significant transactions
4. Omitting, advancing, or delaying recognition of transactions
5. Adjusting assumptions and judgments to manipulate account balances
6. Engaging in complex transactions

Question 20

What are the procedures against management override of controls (MOC)?

Answer 20

1. Test the appropriateness of journal entries
2. Review accounting estimates for bias
3. Evaluate the business rationale for significant transactions outside normal business

Question 21

What are the two levels of risk?

Answer 21

1. Financial Statements Level
2. Assertion Level

Question 22

What should an auditor do if misstatement due to fraud is suspected and senior management is involved?

Answer 22

1. Reevaluate the assessment of the risk of material misstatement due to fraud
2. Consider the impact on nature timing and extent of audit procedures to respond to the audit risk.
3. Question the reliability of previously obtained evidence
4. Assess doubts about completeness and truthfulness of representation
5. May consider to withdraw.
6. Communicate with TCWG and regulatory authorities after obtaining legal advice

Question 23

2. What are some examples of conflicting or missing evidence?

Answer 23

1. Missing documents.
2. Documents that appear to have been altered.
3. Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.
4. Significant unexplained items on reconciliations.
5. Unusual balance sheet changes, changes in trends, or financial statement ratios (e.g., receivables growing faster than revenues).
6. Inconsistent, vague, or implausible responses from management or employees regarding inquiries or analytical procedures.
7. Unusual discrepancies between records and confirmation replies.
8. Large numbers of credit entries and adjustments to receivables records.
9. Unexplained or inadequately explained differences between accounts receivable sub-ledger and receivable statements.
10. Missing or non-existent canceled checks in circumstances where canceled checks are expected in bank statements.
11. Missing inventory or physical assets of significant magnitude.
12. Unavailable or missing electronic evidence inconsistent with record retention practices.
13. Fewer responses to confirmations than anticipated.
14. Inability to produce key IT systems evidence.
15. Implementation activities for program changes and deployments.

Question 24

What are some examples of discrepancies in accounting records?

Answer 24

1. Transactions not recorded completely or timely.
2. Unsupported or unauthorized balances or transactions.
3. Last-minute adjustments significantly affecting financial results.
4. Evidence of employees accessing systems and records inconsistently with their authorized duties.
5. Tips or complaints to the auditor about alleged fraud.

Question 25

What are examples of problematic or unusual relationships between the auditor and management?

Answer 25

1. Denial of access to records, facilities, employees, vendors, or others from whom audit evidence might be sought.
2. Undue time pressures imposed on auditors.
3. Complaints to management about the audit.
4. Unusual management intimidation of engagement team members.
5. Unusual delays by the entity in providing requested information.
6. Unusual reluctance for the auditor to access key IT resources.
7. Denial of access to key IT operations staff.
8. Unwillingness to add or revise disclosures to make financial statements more complete and understandable.