Addthis Arens Chapter11

Fraud Auditing
Chapter 11

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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Learning Objective 1
Define fraud and distinguish
between fraudulent financial
reporting and misappropriation
of assets.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Types of Fraud
 Fraudulent financial reporting
 Misappropriation of assets

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 2
Describe the fraud triangle and
identify conditions for fraud.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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The Fraud Triangle
Incentives/Pressures

Opportunities

Attitudes/Rationalization

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Examples of Risk Factors
for Fraudulent Reporting
Incentives/Pressures:
 Financial stability or profitability is threatened by
economic, industry, or entity operating conditions
 Excessive pressure exists for management to
meet debt requirements
 Personal net worth is materially threatened

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Examples of Risk Factors
for Fraudulent Reporting
Opportunities:
 There are significant accounting estimates that

are difficult to verify
 There is ineffective oversight over financial
reporting
 High turnover or ineffective accounting, internal
audit, or information technology staff exists
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Examples of Risk Factors
for Fraudulent Reporting
Attitudes/Rationalization:
 Inappropriate or inefficient communication
and support of the entity’s values is evident
 A history of violations of laws is known
 Management has a practice of making
overly aggressive or unrealistic forecasts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Examples of Risk Factors
for Misappropriation of Assets
Incentives/Pressures:
 Personal financial obligations create pressure
to misappropriate assets
 Adverse relationships between management
and employees motivate employees to
misappropriate assets

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Examples of Risk Factors
for Misappropriation of Assets
Opportunities:
 There is a presence of large amounts of cash
on hand or inventory items

 There is an inadequate internal control over
assets

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Examples of Risk Factors
for Misappropriation of Assets
Attitudes/Rationalization:
 Disregard for the need to monitor or reduce
risk of misappropriating assets exists
 There is a disregard for internal controls

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 3
Understand the auditor’s

responsibility for assessing
the risk of fraud and detecting
material misstatements due to
fraud.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Assessing the Risk of Fraud
SAS 99 provides guidance to auditors
in assessing the risk of fraud.
SAS 1 states that, in exercising professional
skepticism, an auditor “neither assumes that
management is dishonest nor assumes
unquestioned honesty.”

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Sources of Information Gathered
to Assess Fraud Risks
Communication
among audit team

Inquiries of
management

Risk
factors

Analytical
procedures

Other
information

Identified risks of material misstatements due to fraud
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Documenting Fraud
Assessment
 Discussion
 Procedures
 Specific risks
 Reasons
 Other conditions and analytical relationships
 Nature of communications

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Learning Objective 4
Identify corporate governance
and other control environment
factors that reduce fraud risks.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Corporate Governance Oversight
to Reduce Fraud Risks
1. Culture of honesty and high ethics
2. Management's responsibility
to evaluate risks of fraud
3. Audit committee oversight

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Example Elements for a Code
of Conduct
 Organizational code of conduct
 General employee conduct

 Conflicts of interest
 Outside activities, employment, and directorships
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Example Elements for a Code
of Conduct
 Relationships with clients and suppliers
 Gifts, entertainment, and favors
 Kickbacks and secret commissions
 Organization funds and other assets
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Example Elements for a Code
of Conduct
 Organization records and communications
 Dealing with outside people and organizations

 Prompt communications
 Privacy and confidentiality
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Organizational Factors
Contributing to Risk of Fraud
Collusion between
employees and
third parties
Inadequate
internal
controls
Management
override of
internal controls
2003

1998

48
31
33
39
58
59
31
36
36
1994

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Organizational Factors
Contributing to Risk of Fraud
Collusion between
employees and
management
Lack of control
over management
by directors
Ineffective or
nonexistent ethics or
compliance program
2003

1998

15
19
23
12
11
6
10
8
7
1994

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 5
Develop responses to identified
fraud risks.

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Responding to the Risk of Fraud
Change the overall conduct of the audit
to respond to identified fraud risks.
Design and perform audit procedures
to address identified risks.
Design and perform procedures to
address the risk of management
override of controls.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 6
Recognize specific fraud risk
areas and develop procedures
to detect fraud.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Initial Detection Method for Million Dollar
Schemes
42.3%

Type of Detection

Tip

46.2%
22.8%

By Accident

20.0%

18.6%
19.4%

Internal Audit

16.7%
23.3%

Internal Controls

$1,000,000+

15.8%

External Audit

All Cases

9.1%
6.0%
3.2%

Notified By Police
0%

10%

20%

30%

40%

50%

Note: The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection
method.Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
©2010
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Specific Fraud Risk Areas
 Revenue and accounts receivable fraud risks
 Inventory fraud risks
 Purchases and accounts payable fraud risks
 Other areas of fraud risk

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 7
Understand interview techniques
and other activities after fraud
is suspected.

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Responding to Misstatements That
May Be the Result of Fraud
When fraud is suspected, the auditor gathers
additional information to determine whether
fraud actually exists.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Types of Inquiry Techniques
 Informational inquiry
 Assessment inquiry
 Interrogative inquiry
 Evaluating responses
 Listening techniques
 Observing behavioral cues
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End of Chapter 11

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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