Class 9

Costs of Financial Statement Fraud

Direct economic losses, increased legal and insurance costs, loss of productivity, adverse impact on employee morale, loss of customer goodwill, loss of supplier trust, stock market losses, loss of public confidence in the quality and reliability of financial statements.

Harmful Impacts of Financial Statement Fraud

Undermines the reliability, quality, transparency, and integrity of the financial reporting process, jeopardizes the integrity and objectivity of the auditing profession, diminishes the confidence of capital markets and market participants, makes capital markets less efficient, adversely affects the nation's economic growth and prosperity, results in large litigation costs, destroys careers of individuals involved, causes bankruptcy or sustained economic losses by the company engaged in the fraud, encourages regulatory intervention, impacts normal operations and performance of alleged companies, erodes public confidence and trust in the accounting profession.

Misstatements Due to Errors

An inaccuracy in gathering or processing data from which financial statements are prepared, an omission of an amount or disclosure, a financial statement disclosure that is not presented in accordance with GAAP, an incorrect accounting estimate due to overlooking or clear misinterpretation of facts, judgements of management concerning accounting estimates that the auditor considers unreasonable or accounting policies that the auditor considers inappropriate.

Fraudulent Misstatements

involves intentional misstatements.

Types of Fraud Misstatement

Fraudulent financial reporting (intended to deceive financial statement users) and misappropriation of assets (theft of assets that cause financial statement misstatements).

Examples of Misappropriation of Assets

Embezzling cash, stealing physical assets and intellectual property, causing the entity to pay for goods or services not received (payments to dummy accounts), using an entity's assets for personal use, skimming cash receipts, creating ghost/fictitious employees, fictitious vendor schemes, overstating expenses.

Examples of Fraudulent Financial Reporting

Manipulation, falsification, or alteration of accounting records or supporting documents used to prepare financial statements, misrepresentation in, or intentional omission from, the financial statements of events, transactions, or significant information, intentional misapplication of accounting principles relating to amount, classification, manner of presentation, or disclosure.

Management's Ability to Perpetrate Fraud

Management frequently is in a position to directly or indirectly manipulate accounting records and present fraudulent financial information. Fraudulent reporting often involves management override of controls.

Concealment of Fraud

Withhold evidence.

Misrepresent information

To provide false or misleading information in response to inquiries.

Falsify documentation

To alter shipping documents, forge signatures, or approvals.

Conceal fraud through collusion

To hide fraudulent activities by working together with others.

Auditor's responsibility regarding material misstatements

The auditor is responsible to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.

Auditor's responsibility for preventing and detecting fraud

The auditor is not responsible for preventing fraud or detecting all frauds; management is responsible for designing and implementing controls to prevent, deter, and detect fraud.

Auditor's fraud risk assessment

The auditor should assess the risk of material misstatement due to fraud at both the financial statement and assertion levels.

Steps in the fraud risk assessment process

Engagement team discussion, inquiry of management, analytical procedures, understanding the period-end close process, and identifying fraud risk factors.

Auditor responses to fraud risk at the financial statement level

Responses include assigning more experienced personnel, evaluating accounting policies, incorporating unpredictability in audit procedures, increasing testing at Year End, and addressing management override.

Auditor responses to fraud risk at the assertion level

Perform tests of controls that mitigate the risk and perform substantive procedures that directly respond to the risk.

Communication of fraud

The auditor must communicate evidence of fraud to the appropriate level of management and report fraud involving senior management to the Audit Committee.

Disclosure of fraud

Disclosure outside the client may be required in certain circumstances, such as legal requirements or inquiries from a successor auditor.