Chapter 10b: Assessing and Responding to Fraud Risks

Responding to the Risks of Fraud

When the auditor identifies risks of material misstatements due to fraud, auditing standards require the auditor to develop responses to those risks a three levels:

–Overall responses

–Responses at the assertion level

–Responses related to management override

Overall Response

Discuss with management

Assign more experienced personnel to the engagement

Consider management’s choice of accounting principles

Incorporate unpredictability

Responses at the Assertion Level

Change the nature of the audit procedures

Change the timing of audit procedures

Change the extent of audit procedures

Responses to Address Management Overide

Examine journal entries and other adjustments for evidence of possible misstatements due to fraud

Review accounting estimates for biases

Evaluate the business rationale for significant unusual transactions

Update Risk Assessment

Auditors should be alert for the following:

–Discrepancies in the accounting records

–Conflicting or missing audit evidence

–Problematic or unusual relationships between the auditor and management

–Results from substantive or final review stage analytical procedures that indicate a previously unrecognized fraud risk

–Responses to inquiries that are vague

Specific Fraud Risk Areas Revenue and Accounts Receivable

Three main types of revenue manipulations are:

–Fictitious revenues

–Premature revenue recognition

–Manipulation of adjustments to revenues

Specific Fraud Risk Areas

Many potential warning signals or symptoms indicate revenue fraud

–Useful procedures include analytical procedures, data analytics, and testing for documentary discrepancies

Specific Specific Fraud Risks Revenue and Accounts Receivable

Misappropriation of receipts involving revenue include:

–Failure to record a sale

–Theft of cash receipts after a sale is recorded

Warning signs

–Internal controls, analytical procedures and other comparisons may be useful

Inventory Fraud Risks

Inventory is susceptible to:

–Manipulation by managers who want to achieve certain financial reporting objectives

–Misappropriation because it is usually readily saleable

Warning signs

–Analytical procedures are one useful technique for detecting inventory fraud

Purchase and Accounts Payable Fraud Risks

The most common fraud in the acquisitions area:

–Perpetrator issues payments to fictitious vendors and deposits the cash in a fictitious account

Purchases and Accounts Payable Fraud Risks

The most common fraud in the acquisitions area:

–Perpetrator issues payments to fictitious vendors and deposits the cash in a fictitious account

Other Areas of Fraud Risk

• fixed assets

• intangible assets

• payroll expenses

Auditors are required to document

–Significant decisions made during the discussion among engagement team in planning the audit

–Procedures performed to obtain information necessary to identify and assess the risks of material fraud

–Specific risks of material fraud that were identified at both the overall financial statement level and the assertion level and the auditor’s response to those risks

–Reasons supporting a conclusion that there is not a significant risk of material improper revenue recognition

–Other conditions and analytical relationships indicating that additional auditing procedures or other responses were required, and the actions taken by the auditor in response

–The nature of communications about fraud made to management, the audit committee, or others