Electronic Presentations in Microsoft PowerPoint

Prepared by

Brad MacDonald
SIAST

2009 McGraw-Hill Ryerson Limited

Chapter 17 Fraud Awareness Auditing

Definitions Related to Fraud External Auditors Responsibilities Conditions That Make Fraud Possible, Even Easy Fraud Detection

Financial statement auditors need to understand fraud and potential fraud situations, and they need to know how to ask the right kinds of questions during an audit.
Users of financial statements expect the auditors will detect fraud; however, this is not the purpose of a financial statement audit. Most of the trained and experienced fraud examiners come from government agencies such as Canada Customs, CCRA, RCMP, OAG, the Ministry of Justice, and various police departments.

Fraud consists of knowingly making material misrepresentations of fact, with the intent of inducing someone to believe the falsehood and act upon it and thus suffer a loss or damage.
Employee fraud: The use of fraudulent means to take money or other property from an employer. It usually involves falsifications of some kind.
Three phases of employee fraud:
fraudulent act, conversion of the money or property, and cover-up.

 Embezzlement: A form of fraud involving employees wrongfully taking money or property entrusted to their care, custody, and control, often accompanied by false accounting entries and other forms of lying and cover-up. Defalcation: The term used when someone in charge of safekeeping the assets is doing the stealing. Management fraud: A deliberate fraud committed by management that injures investors and creditors through materially misleading financial statements.

CICA Handbook, paragraphs 5135.02-03

Fraud and other irregularities refer to an intentional misstatement in financial statements, including an omission of amount or disclosure, or to a misstatement arising from theft of the entitys assets. Fraud also involves: i. the use of deception such as manipulation, falsification, or alteration of accounting records or documentation; ii. misrepresentation or intentional omission of events, transactions, or other significant information; or iii. intentional misapplication of accounting principles relating to amount, classification, or manner of presentation of disclosure.

The Handbook definition:

Irregularities are intentional misstatements or omissions. Errors are unintentional misstatements or omissions.
In practice, the auditor will be concerned with a suspected rather than a proven fraud. Intent is difficult to prove.

Final determination of fraud is left to the courts.

External auditors responsibilities under GAAS are:

The auditor should document fraud risk factors identified as being present during the assessment process, and document the auditors response to any such factors.
The auditor should assess inherent and control risks so that the risk of undetected material misstatement from fraud or error is appropriately low.

In conducting the audit, the auditor must presume a risk of fraudulent revenue recognition.
The presumption is rebuttable. If auditors can convince themselves that risk is low, the presumption is rejected.
Auditors must perform procedures and analysis to determine that the risk is actually low. Fraud auditors may be used to assess this risk.

The auditor must consider the consequences of illegal acts and the best way of disclosing such consequences.
Illegal acts may be difficult to detect due to:
efforts made to conceal them, or questions about whether an act is actually illegal, which must be determined in a court of law.

Auditors should inform management about the limitations in detecting illegal acts in the engagement letter.

Numerous fraud cases have involved manipulation of estimates.

Management is responsible for making accounting estimates, and auditors are responsible for evaluating their reasonableness.

External auditors are required to report, among other items, fraud or other illegal acts to the audit committee.
Following the collapse of Enron, US standards in respect to detecting fraud were significantly increased.

External auditors assess the risk of fraud by looking for warning signs.
The lack of awareness of the warning signs of fraud is a frequently cited cause of audit failure. Client dishonesty is the most important warning sign. A 1996 study ranked warning signs from a survey of 130 auditors.

Auditors should inform the audit committee of all irregularities, except those that are clearly inconsequential.
Irregularities involving senior management are never inconsequential.

The probability of fraud is based on three factors:

motive, opportunity, and lack of integrity. When these factors lean in the direction of fraud, it almost certainly will occur.

A motive is some kind of pressure experienced by a person and believed unshareable with friends and confidants.
Psychotic - habitual criminal Egocentric - personal prestige Ideological - a cause that is morally superior Economic - money

An opportunity is an open door for solving the unshareable problem in secret by violating a trust.
The violation may be the circumvention of internal control policies and procedures. Everyone has some degree of trust conferred by a job. The higher the position in the organization, the higher the trust.

Unimpeachable integrity is the ability to act in accordance with the highest moral and ethical values all the time.
Lapses in integrity may occur and be rationalized:
I need it more than the other person. Im borrowing the money and will pay it back. Nobody will get hurt. The company is big enough to afford it. A successful image is the name of the game. Everybody is doing it.

Observation of a persons habits and lifestyle may reveal some red flags.

Fraudster characteristics:
lose sleep take drugs cant relax cant look people in the eye work standing up drink too much
Learning objective 1 2 3

become irritable easily get defensive, argumentative sweat excessively find excuses or scapegoats for mistakes work alone, work late
4 5 6 7 8

Exceptions and oddities to note:

missing documents cash shortages and overages excessive voids and credit memos customer complaints common names and addresses for refunds GL does not balance

inventory shortage alterations of documents duplicate payments employees who cannot be found second endorsements on cheques documents being photocopied dormant accounts becoming active
3 4 5 6 7 8

Learning objective 1 2