Chapter 8 Flashcards
Frau Detection: Red Flags and Targeted Risk Assessment (34 cards)
Describe Management’s Responsibility
- Meet strategic, operational, & performance objectives
- Measure performance
- Communicate results
- SAS: responsible for adopting sound acc policies and establishing & maintaining internal control
- Fair representation of FS
- Provide info to independent auditors
Describe Risk of Management Override & Collusion
- What can be done about it?
Internal Controls cannot control management override
- Prevention not possible in a collusive environment
- Fear of detection
Three Procedures to Identify Breakdowns in internal controls due to override and collision
- Journal entries recorded in the books & record
- Review significant accounting estimates
- Scruitinize one time transactions
How do Collusive Frauds differ from Solo Fraud?
Perpertrators, behavior, association w/ vendor, what type of fraud, doll
- Collusive fraudsters tend to be younger, make, less education
- Less likely to exhibit personal behavior issues like addicition or control issues
- More likely to exhibit unusually close associations w/ vendors and wheeler dealer attitude
- More likely to involve FS, have larger dollar losses and shorter duration
- More likely to be discovered by tip or complaint, internal audit, law enforcement, or by accident
Key Diffs Btw Management Override Frauds and Lack of Control Frauds
Profile, tenure, types of fraud, materiality of fraud
- More likely older, senior level, educated, with shorter tenure
- More likely to engage in corruption and FS fraud, less likely to commit material fraud
- More common outside US
- Orgs antifraud env is + related to likelihood of mgmnt override fraud
- Lack of controls fraud - different from management override –> diff remedies
What is the Role of the External Auditor?
- Reasonable assurance
- Free of material misstatement
- Analytical Procedures
- Expectations Gaap
- Attest fairness of mngmt presentation of info
- Audit Report with opinion
How is fraud considered in FS audits?
SAS # 99 / #113
- Enhanced professional skepticism
- Pre-audit fraud brainstorming
- Interviews w/ management
- Audit test design
Determining factor btw material misstatement from fraud or error
Intent
How Fraud - an intentional misstatement - can be achieved?
3 ways
- Manipulation, falsification, or alteration of underlying accounting data, records, & documentation
- Misrepresentation or omission of events, transacs and other signif info
- Intentional mispplication of accounting principles
What is the concept of Materiality?What does not have materiality threshholds
The magnitude of an omission or misstatement of acc info, in light of surrounding circumstances, makes it probable that judgement of a reasonable person relying on the info would have changed or influenced by the omission or misstatement
- Materiality is a relative concept, qualitive vs quantative aspect
Illegal acts have no materiality threshold
- FCPA only states if material
Relationship btw Earnings Management and Fraud
Deliberate actions by mngmt to meet specific earning objectives for private gain
- Income smoothing: shifting of revenue btw periods
Acc Principles and policies have some degree of choice
- may lead to fraud
- need clear and convincing evidence
Role of BoD & Audit Committee
Primary responsibility
- oversee management
- direct internal auditor
- direct external auditor
Internal controls over fin rep and comp internal control process
Assure - mgmnt has adequately assessed risk of mngmt override or collusion amound top level manages and exec
Help set tone at the top
Establish Anti fraud programs
Ethics training
Instituting a zero-tolerance policy
Proactively Investigate whistleblower tips and protect them
Role of Internal Auditors and Purpose
Increased perception that fraud perpetrators will be detected
Operations:
- Evaluate segment, product line, and division profitability
- Improve internal productivity
Financial Reporting
- Evalutation of internal controls
What is Fraud Detection and how can it be accomplished?
The first sign or symptom that a fraud has occurred
- Can be accomplished through use of well designed internal controls, supervison, & monitoring, as well as the active search of evidence
More work needs to be done to ensure that other explanation, like human error, are not at the root of this system
Initial fraud detection steps: 1st steps towards concluding predication has been met - far from evidence needed to convince jury
Ideal Internal Control Environment
- Commitment to integrity & ethical & core values
- Commitment to competence
- An independent BoD & Audit Committe that participates in the internal control
- Management’s attitudes, philosophy, and operating style concerning important internal controls and operational issues
- Organizational Structure, include lines of responsibility and authority, particularly as it relates to the control environment & operational expectation
- Communications about the importance of control related matters, ethics, anti-fraud awareness and commitment, organizational and operating plans, employee job descriptions & related policies
- Human resources policies and procedures
How to create a clear & unwavering commitment to a culture of honesty
- Hiring honest employees
- Training them in all aspects of their duties & responsibilities
- Delivering fraud awareness in organization orientation and ongoing communications
- Providing fraud risk assessment methodology to appropriate personnel
How Red Flags are used to Detect Fraud?
- Does the anomaly have supporting documentation?
- Does the documentation appear to be falsified, altered, or fictitious?
- Does the transaction and its reflection in the FS makes sense?
- Does the transaction make sense in light of the company’s operations, goals, and objectives?
- Does the totality of this and similar transaction make sense analytically when evaluted in comparison to the economy, the industry, key competitor, and other acc #s?
- Does the transaction have proper approval and the proper authority levels?
- Does anything else about the transactions or its nature make it appear suspicious?
Most common detection methods (stats)
**Tips **
- 33% frauds by tips in small orgs vs 44% frauds
- Many are fake
Accidental discovery and tips
- Account for 50% of all frauds
Why may employees not report and how to fix this?
Employees may not report for fear of getting someone in trouble
Whistleblower or fraud hotline
- Easy and Anonymous
- Tipster must provide sufficient detail
Behavioral Red Flags
Lifestyle Symptoms
- living outside of means
- easy to ovserve
- most perps spend gains almost immediately
Unusual Behaviors
- Fear causes fraudster to act differently
- stress changes fraudsters behavior
- Difficult to discover fraud from clues alone
- Combine with other red flags
Analytical Anomolies
- Transaction or FS relationship does not make sense
- Transacs are too small or too large when compared to normal activity
- Patterns or breaks in patterns
- Analytical anomalies are common and should be pursued until fraud is discovered or ruled out
Some Analytical Anomolies
- Unusual & missing items
- Large or smaller than usual items
- No pattern when you would expect one
- A break in a pattern that is unexpected
- Round, even transaction amounts
- Cash transactions instead of transaction by check
- Large consistent transactions
- Unusual timing of transactions
- Unexpected transaction recipients or beneficiaries
- Unexplained cash shortages
- Unexplained inventory shortages
- Deviation from specifications
- Increased Scrap
- Excessive Purchases
- Too many debit or credit memo
Anomolies that include strange relationships
rev, inventory, volume
Revenues Increasing
- But Inventory decreasing
- But AR decreasing
- But AR increasing at a greater %
Inventory Increasing
- But A/P decreasing
- But decreasing warehouse cost
Increased Volume
- But increased cost per unit
- But decreased scrap
Some Accounting Anomalies
- Missing documents
- Old items being carried on bank & other account reconciliation from one pd to the next period
- Excessive void or credit memos
- Common names, addresses, or phone numbers of payees or customer
- Name, addresses, or phone #s that are the same as those of employees
- Increases in past due A/R
- Excessive write-offs of A/R
- Increase in # & amnt of reconciling items
- Alteration on documents
- Duplicate payments
- Second endorsements on checks
- Breaks in check, invoice, purch order, other squences
- Questionable handwriting
- Photocopied documents
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