Flashcards in Becker AUD 3.4 - Fraud Risk Deck (33):
What is the DIFFERENCE between Error and Fraud?
Error = Unintentional misstatements or omissions of amounts or disclosures in the F/S.
Fraud = Intentional act by one or more individuals among MGT, charged with governance (board of directors / audit committee), Employees, or 3rd parties using DECEPTION that results in F/S misstatements.
Fraudulent Financial reporting:
1) What is it this?
2) What are 4 acts that Management can do in to make Fraudulent financial reporting deceiving?
1) Fraudulent Financial reporting = intentional misstatements or omissions done to deceive F/S users.
2) 3 Acts:
a) Manipulation, falsification, or alteration of ACCTG. RECORDS or Supporting DOCUMENTS which financial statements are prepared;
b) Misrepresentation in, or intentional omission from the F/S or Events, Transactions, or other significant information,
c) Intentional MISAPPLY of Accounting Principles relating to AMOUNTS, classification, manner of Presentation or Disclosure.
D) Having a complex organizational structure with unusual lines of AUTHORITY. Such structure allows fraud activities to happen and to be concealed.
Scenarios and Questions:
1) If you see Dec year 1 FS with increased high sales revenue of $100,000 and a Jan Year 2 FS with decreased sales revenue $100,000, is this a Fraudulent Financial reporting, misappropriation assets, theft of assets, embezzling cash receipts?
2) Lack of independent checks on personnel in looking over the actual assets and documents to them is an example of "Misappropriation of assets?"
3) Are these examples of Fraud Risk factors relating to Fraudulent Financial Reporting:
a) Strained relationship between MGT and predecessor auditor
b) High turnover of senior MGT
c) Inability to generate CFLO from operations
4) Inability to generate cash flows from operations while reporting substantial earnings (net income, profit) growth is a sign of Fraudulent Financial reporting. True or false.
5) Management's lack of interest in increasing entity's stock trend is a sign of Fraudulent financial reporting. True or False.
1) Fraudulent Financial reporting. This because when comparing these two separate F/S seeing a increase in year 1 Dec and then same amount of Decrease in year 2 Jan F/S, then this shows that there is manipulation of the Financial records.
There is no evidence in this scenario of misappropriation of assets or embezzlement of cash or theft of assets. If there was, then the scenario should say during a physical count of assets, something is missing.
4) True. This because this shows a inconsistency where not able to generate cash flows from operations means the company is not doing will in increasing its Revenues (thus increased earnings). But, when there's a substantial earnings grown being reported on the F/S at the same time, then it looks very suspicious that someone is making up the numbers on the F/S.
5) False. MGT's lack of concern for entity's stock trend does not alarmed auditor's attention about fraudulent F/S reporting. It is when the MGT has adopted aggressive policies to increase entity's stock trend raises the issue that there is fraudulent F/S reporting involved.
What is the difference between
Misappropriation of assets
Misappropriation of assets: Defalcation or theft, stealing, embezzle of assets. This results in F/S NOT conform with GAAP.
This is done through 1 or more people in MGT, employees, or 3rd parties to steal assets or cause Company to pay something that it does not receive in return.
What is the primary objective of "Fraud Brainstorming Session?"
What 3 areas is discussed during a fraud brainstorming session?
Discussion regarding the potential for material misstatement due to fraud.
1) How and where F/S might be susceptible to MISSTATEMENTS due to Fraud
2) How MGT could enact the FRAUD activity in financial reporting and HIDE the activity
3) How ASSETS could be MISAPPROPRIATED
True or false:
1) A situation of 2 employees from different departments that are bypassing internal controls to commit a theft is something that is hard to detect by the Auditor.
2) Fraud Risk assessment and the Risk of Material Misstatements (inherent risk and control risk) assessment is an On-going process.
3) Illegal payment to foreign official that was not recorded has a MATERIAL effect (big impact) on company's F/S no matter how small the $$ amount is.
This is because it's not easy to trace what fraud activity was being done by which people that are working in different departments of the company. Also, the perpetrators of different departments can hide their tracks since it is hard to Trace activity of one department to another totally different department.
2) True. Assessments on fraud risk and risks of material misstatements must be done on an On-going basis at each stage of the Audit. It's NOT done only at One stage and that's it.
Fraud risk factors consist of 3 items - what are they?
1) Incentives/Pressures: A reason to commit fraud
2) Opportunity: a lack of effective controls
3) Rationalization/Attitude (Ethics/Integrity): an attempt to JUSTIFY fraudulent behavior.
True or false:
1) because of Reasonable Assurance that F/S are free from material misstatement result from errors or Fraud, even the best properly planned audit plan may fail to detect fraud.
2) Risk of NOT detecting fraud-caused material misstatement is LOWER than not detecting error-caused misstatements.
3) Risk of NOT finding MGT-fraud-created misstatement is GREATER than Employee-conducted fraud. This because MGT can manipulate accounting records, present fraudulent F/S, or OVERRIDE controls.
4) Fraud is often to detect because those involved can conceal them. This includes various parties working together to commit fraud and conceal the fraud.
5) Auditor's ability to find fraud DEPENDS on perpetrator's skillfulness, Frequency and Extent of Manipulation, Degree of Collusion involved, the relative SIZE of individual amounts manipulated, and the Seniority (how long individuals worked in company and know the insides and outs of the company) involved.
1) True. Auditors cannot do Absolute Assurance (check every single transaction) because it costs too much and it would take too long. So, only reasonable assurance is obtained and in so doing, auditor may fail to detect fraud.
Risk of NOT detect Fraud-related misstatements is HIGHER than error-related misstatements.
3) True. MGT has more direct access to F/S information and override mechanisms to commit fraud. Also, the MGT doing this are able to conceal such fraudulent activities.
4) True. It is hard to find evidence of a fraud that is very concealed. In addition it is hard to find evidence of fraud committed by various people in the company.
5) True. These are the factors that deals with able to find the fraud being committed by the perpetrators.
True or false:
1) A large number of bearer bonds on hands represents the HIGHEST RISK of material misstatements arising from Misappropriation of Assets.
2) A large number of Fixed Assets with no identifiable serial numbers represents the HIGHEST RISK of material misstatements arising from Misappropriation of Assets.
3) A large number of inventory items with sales low prices represents the HIGHEST RISK of material misstatements arising from Misappropriation of Assets.
4) A large number of transactions processed in short period of time represents the HIGHEST RISK of material misstatements arising from Misappropriation of Assets.
1) TRUE. This because Bearer bond are unassigned with NO records of owner(s) or Transactions involved ownership. With no records, it's hard to trace bond to owner to find out who is committing the Fraud. Historically bearer bonds have been used to facilitate money laundering, tax evasion, and to conceal business transactions.
2) TRUE. This because with no serial numbers to identify what fixed assets were purchased or sold, it will be hard to find out if there was any misappropriation of like Cash proceeds and/or AR on selling assets or money spent to acquire fixed assets. Also, it will be hard to determine if a person has stolen a fixed asset like equipment or machine.
3) False. Large transactions amounts of inventory sales at low sales price may result in a misappropriation that is NOT material to the user of the F/S. (even though inventory items that are of cheap price can be misappropriated if they are easy to steal).
4) FALSE. Not necessary because such large transactions done so quick would be hard for the FRAUDSTER to commit the fraud and hide the fraud activity right away.
What is Professional skepticism?
Auditor's questionable mind (set) to critically assess the information in front of them to verify that the information gathered is correct -OR- there is a misstatement.
True or False.
1) In order to have professional skepticism (questioning mind), the auditor must rely on past experience in auditing a client to help find fraud.
2) Auditor should not rationalize or dismiss information that could indicate that a fraud is happening while auditing the client.
3) Fraud assessment is not an ongoing process. This because once the auditor as assessed the Risk of material misstatement (inherent risk x control risk), they make a one-time permanent Fraud assessment and that's it.
1) FALSE. Do NOT RELY on past experience in auditing the client. This because what happens in the past stays in the past. Using past knowledge to find a fraud currently will not work because things in the company's environment could change drastically. So, what you know before may not work now.
2) True. This because to have a questioning mind, you must be aware that there could be some information where a fraud could be occurring.
3) FALSE. Fraud assessment is an on-going process. This because during the course of the audit, new information may pop up telling the auditors that "hey there could ACTUALLY be FRAUD" going on.
During an audit where FRAUD is being assessed and considered,
what is the responsibility of the Auditor and MGT for this case?
Auditor's job is to: design (plan and perform) the obtain to obtain REASONABLE ASSURANCE about whether F/S are FREE of material misstatements due to error or FRAUD.
Auditor should assess the Risk of Material misstatement on F/S due to fraud and use this assessment to design and perform the AUDIT procedures.
MGT responsibility: Design and implement internal control programs to Prevent, Deter, Detect Fraud.
What are the 3 methods used to obtain information to identify FRAUD risks?
1) Inquiries with Entity Personnel (MGT, employees in F/S reporting, Operating personnel, internal auditors, in-house legal counsel, board of directors/audit committees) regarding their views of Fraud risk.
2) Consider the results of Analytical Procedures done during the Planning Stage and Final Review Stage of the audit
3) Evaluate Fraud Risk Factors.
True or False
1) Analytical procedures are required to be done by Auditor during the "Planning Stage" and "Final Review Stage" of the audit.
2) Analytical procedures can consist of ratio analysis in using financial data.
3) Analytical procedures performed during the Planning stage of Audit use DATA aggregated at a HIGH LEVEL to assess fraud risk.
4) Using aggregated data at a high level in analytical procedures does NOT give a broad indication regarding fraud risk.
5) Analytical procedures can replaced the tests of internal controls to assess control risk.
6) Analytical procedures are often used to develop auditor's preliminary judgement about materiality.
7) Analytical procedures usually involve the comparison of Assertions developed by MGT to ratios calculated by an auditor.
4) False. Using aggregated data at a high level in analytical procedures DOES give a broad indication regarding fraud risk.
5) False. Analytical procedures are not used in assessing control risk.
6) FALSE. Analytical procedures are not used for Preliminary judgement on Materiality.
7) Analytical procedures does not involve any comparison between Ratios and MGT's assertions.
When find fraud, communicates with fraud issues:
True or False:
1) Report to MGT at least one level above those involved in fraud (even IMMATERIAL FRAUD) inside the company.
2) Fraud causing MATERIAL MISSTATEMENT in F/S should talked with only just management and report directly to those charged with governance (Board of Directors / Audit committee)
3) If find evidence that fraud was being committed by the Senior Management (regardless if it impacts the F/S or not), report DIRECTLY to Board of Directors and/or Audit Committee.
4) Auditor can choose to talk about IDENTIFIED FRAUD RISKS in other communications with those charged with governance (board of directors).
Q.) If auditor find information showing significant deficiencies OR material weakness to internal controls, then report it to which people in the company?
1) True. When find fraud (including immaterial fraud), contact to those ABOVE those involved in fraud to rectify the situation.
2) False. When find FRAUD related to a MATERIAL MISSTATEMENT in F/S, then talked to SENIOR MANAGEMENT and report to Board of Directors / Audit committee.
3) True. If senior management is doing fraud in relation to F/S, then report directly to the Board of Directors (charged w/ Governance)
Q) Senior management and those charged with Governance (Board of Directors / audit committee)
Communicating on FRAUD with Outside parties:
True or False:
Auditor has the responsibility to disclosure fraud outside of Senior Management and charged with governance (board of directors) to like the SEC or a Board or regulatory body.
False. It is not the auditor's responsibility to do so. If there is a situation where an auditor is stuck in a situation where the Auditor cannot get the Board of Directors to get the management to resolve the FRAUD activity, the auditor just withdraw from the engagement.
When doing substantive testing on a particular account, the auditor gets copies of the original invoices. However, the original copies have been misplaced. What does the auditor do at this point?
Re-evaluate the risk of Fraud.
Design and performed ALTERNATE tests related to transactions affecting the account (to determine if there is misstatements are present or not. Determine if there is fraud really involved). This is done because you do not know if the photo-copies of the originals have been altered.
If specific information concerning a possible act of Non-compliance with laws and regulations comes to the Auditor's attention, the Auditor would use Additional Audit Procedures to determine whether?????
Whether: Act of noncompliance with laws and regulations HAS IN FACT OCCURRED.
Do you need to express a Qualified opinion or adverse opinion with noncompliance with laws and regulations occurred has already been accounted for and/or disclosed in the F/S?
No, you don't have to express Qualified (except for) opinion or Adverse opinion.
This because F/S can be fairly stated even if not following certain laws/regulations and GAAP rules. As long such departure is accounted for or disclosed in the F/S, then NO need to disclose Qualified opinion or adverse opinion.
Is the Auditor responsibility to prevent noncompliance with laws and regulations of a company?
No. This Auditor is not responsible for preventing company's non-compliance with laws or regulations.
The auditor's responsibility is to obtain Reasonable Assurance to express an opinion on the F/S and to ensure that F/S is free of MATERIAL misstatement.
What are the 7 types of conditions that heightens auditor's concern for Risk of material misstatement coming from Fraudulent F/S reporting?
1) Discrepancies in accounting records (i.e. Accounting records and files not PRODUCED promptly; Only photocopies of the original copes are available while the original copies are misplaced)
2) Conflicting or missing evidential matters.
3) Problematic relationships between the auditor and management
4) Objections by MGT to the auditor meeting privately with the audit committee.
5) Accounting policies that appear INCONSISTENT with industry practices that are widely recognized and prevalent.
EXAMPLE: MGT interested in using AGGRESSIVE ACCOUNTING practices to maintain entity's earnings over time.
6) Frequent changes in accounting estimates that DO NOT appear to result from changing circumstances.
7) Tolerance of violations of the company's code of conduct.
When there is a high Fraud Risk, auditor does what to decrease detection risk?
Design the audit procedures to help reduce audit risk. This is done by doing more procedures. This also includes altering the nature, extent and timing of audit procedures.
Does the presence of three risk fraud factors means that there is really a fraud going on in the F/S?
No. This because the presence of the 3 fraud risk factors (opportunity, incentive, rationalization) IS NOT an absolute indicator that there is fraud.
it's the the auditor's responsibility to Plan and Perform the Audit to obtain reasonable assurance whether F/S are free from material misstatement whether caused by error or fraud. this includes a specific assessment of RISK of material misstatement due to fraud. As the auditor does this, the Auditor has met his/her responsibility in doing the audit.
True or False.
1) The auditor is required to disclose material management fraud to Principal stockholders when Senior MGT and Board of Directors fail to acknowledge fraudulent activities.
2) Auditor is required to communicate to those charged with governance (board of directors or audit committees) of minor fraud acts conducted by low-level employees, even if amounts are immaterial.
3) Fraud is disclosed to SEC only in certain limited circumstances USING required regulatory reports.
4) Management that is solely dominated by One person who is also a shareholder increases the risk of Material misstatement on F/S.
5) Nonfinancial management (NOT financial management) participation in selecting Accounting Principles MIGHT heighten auditor's concern on Fraudulent F/S reporting risk.
Auditor's responsibility does NOT include reporting Fraud to parties outside the Senior Management and Board of directors. Outside parties include like Stockholders.
Auditor is required to report to Board of Directors of material fraud activities done by Senior management. Not low level employees.
Only in certain limited circumstances where Auditor reports Fraud to SEC via required regulatory reports.
This because Management consisting of 1 person shows that the company has no checks and balances to prevent and deter that one person from manipulating the F/S.
Auditors should be aware of Non-financial management selecting and probably manipulating the Accounting policies to affect Financial reporting.
FYI - Financial MGT is expected to be involved in selecting Accounting principles.
Auditor's audit plans only provides Reasonable assurance on:
Direct Effect of non-compliance with Laws and regulations
Indirect effect of non-compliance with laws and regulations.??
Direct Effect of non-compliance with Laws and regulations.
Name 3 examples of oversight (or a check/balance) on a entity's F/S so the F/S are NOT materially misstated.
1) Internal auditors direct access to Board Directors and Entity's management to address concerns to be fixed.
2) Outside parties establishing external policies on the company's accounting practices. (Outside parties' check on company's accounting procedures and policies to be followed through)
3) Charged with governance individuals (board of directors / audit committee) overseeing the entity's F/S policies.
What is the review state of the audit?
This is usually the last stage of the audit where the auditor performs analytical procedures to consider the Risk of Material misstatement (inherent risk x control risk).
FYI - The Review stage is NOT where the auditor verifies clerical accuracy of client schedules and checking to see if Internal control weaknesses have been corrected by company's Management.
When there is a HIGH risk of material misstatement due to fraud related to Inventory function, do you request to get management involved to closely monitor the inventory function?
No. Having the MGT involved may increased the chance o the MGT to override controls to manipulate information on the inventory function that would result in materially misstated F/S.
Usually, you do not want to have MGT involved in handling internal controls procedures because of the risk that the MGT may get away with bypassing the internal controls to manipulate the F/S.
So, it's better to get something outside of MGT to make sure the Inventory function's Risk of Material misstatement is mitigated.
Name 3 appropriate responses to mitigate the Risk of Material misstatements (inherent risks x control risk) on the inventory function.
1) Observe inventory counts on an unannounced basis. Auditors come in on unannounced dates/times to check up on the inventory themselves.
2) Requesting inventory counted on date close to Last day of reporting period. This so an accurate final count can be done.
3) Assigning more experienced audit engagement personnel will help find more areas of potential misstatements.
Name 3 types of aids to help evaluate the RISK of improper revenue recognition.
1) Trend analysis of revenues and sales returns by month.
2) Compare sales volume with production capacity to see if too much Sales volume over production capacity may indicate there is fraud
3) Compare revenue reported by month and by product line for current year and prior years (dis-aggregated data) to see if there is unusual relationships between Monthly revenue reports by Product Line in current year and past year to see if there is fraud going on.
Name 3 types of journal entries situations (nonstandard or unusual entries) an Auditor is going to examine the most to address the risk of management override of controls.
1) Journal entry recorded as Post-closing entry that has NO explanation or description
2) Journal entry to a seldom-used account.
3) Journal entry done by the a person who does not usually make journal entries.
1) What 3 types of inquiries the auditor should make in order to identify Risks of Material Misstatements due to fraud?
2) Do the auditor inquire with Management or operating personnel regarding Internal controls, how it functions to prevent, detect, or deter material misstatements due to fraud?
3) Fraud risk factors (incentives / processes, opportunity and rationalization/attitude) is discussed with Audit Engagement personnel during the Planning Stage or the Overall review stage of the Audit?
1) 3 types of inquiries
a) Inquiry on whether Particular business segment for which a risk of fraud may be more likely to exist.
b) How management communicates to employees its views on acceptable business practices.
c) Whether management is aware of any allegations of fraud.
2) Auditor discusses with Management to get information about Internal controls and how it works in terms of preventing, detecting, determining material misstatements due to fraud. Auditor does NOT talk with operation personnel because it's the Management that is directly responsible with Internal Controls' design, implementation and maintenance.
3) Discussed during the Planning stage to indicate if there is a greater risk of fraud so that that engagement team and designed and implement appropriate audit procedures to detect the fraud and get the MGT to resolve it.