2D - Fraud, Considerations and Characteristics

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2D - Consideration and Characteristics of Fraud Fraud - An intentional act - Involves one or more individuals among management, those with governance, employees, or third parties - Applies the use of deception that results in a misstatement in financial statements that are subject of an audit Fraud vs. Error in a Financial Statement - Error : An unintentional misstatement or omission - Fraud : An intentional misstatement or omission - The purpose of the audit is to opine was to whether the financial statements are presented fairly in all material respects. o In accordance with an applicable financial reporting framework o Whether due to fraud or error Fraudulent Financial Reporting - Misstatements or omissions intended to deceive financial statement users o Manipulation, falsification, or alteration of records o Misrepresentation or omission of events, transactions, etc. o Intentional misapplication of accounting principles Misappropriation of Assets - Thefts of assets or defalcations o Embezzling receipts o Stealing assets o Causing entity to pay for goods and services NOT received o Using entity assets for personal use Risk Factors - Management Attributes & Control Environment - High turnover of top management - Management dominated by one individual - Strained relationship with auditors - Overworked internal audit staff and/or accountants - Management does NOT support internal control - Nonfinancial management involved in choice of accounting methods - History of violations Risk Factors - Industry Conditions - Declining or highly competitive industry - Industry with rapid changes
Risk Factors - Operating Characteristics and Financial Stability - Significant related party transactions - Unusual or complex transactions - Declining cash flows while reporting earnings growth - Operating in tax-have jurisdictions - Unrealistic incentive programs - Hostile takeover - Poor financial condition Risk Factors - Misappropriation of Assets - Susceptibility of Assets to Misappropriation o Related to inherent risk - Internal Controls o Ineffective, inadequate, or NO controls o Related to control risk Fraud Triangle - Rationalization - Pressure or Incentive - Perceived Opportunity Incentive/Pressure Examples - High degree of competition - Declining margins - Vulnerability to rapid changes - Significant declines in market demand - Threat of bankruptcy - Recurring negative cash flows - Third party expectations - Personal financial threats - Compensation incentives - Personal obligations - Known future layoffs - Inconsistent compensation expectations Opportunity Examples - Significant related-party transactions - Significant estimates - Highly complex transactions - Multi-border operations - Ineffective monitoring and oversight - Unstable organization structure - Significant internal control deficiencies - Large amounts of cash on hand - Easily convertible assets - Inadequate segregation of duties - Lack of management oversight
Attitude/Rationalization Examples - Inappropriate values - Known history of violations by management - Excessive interest in earnings trends - Employing tax-motivated transactions - Pushing concept of materiality - Employee dissatisfaction - Frequent disregard for internal control - Tone at the top Conditions Affecting Fraud Risk - Multiple discrepancies in accounting records - Conflicting/missing evidential matter - Problematic/unusual relationship between auditor and client Question #1 Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when: a) The audit committee is an active in overseeing the entity's financial reporting policies b) External policies established by parties outside the entity affects its accounting practices c) Management is dominated by one individual who is also a shareholder d) Internal auditors have direct access to the board of directors and entity management Question #2 Which of the following is an example of fraudulent financial reporting? a) Company management falsifies inventory count tags, therefore overstating ending inventory and understating cost of sales b) An employee diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses c) An employee steals inventory; "shrinkage" is charged to cost of sales d) An employee "borrows" small tools from the company; cost is reported as miscellaneous expense Question #3 Which of the following statements best describes the auditor's responsibility to detect fraud risk factors relating to financial stress of employees or adverse relationship between the entity and its employees? a) The auditor is REQUIRED to plan the audit to detect these risk factors. b) These factors relate to fraudulent financial reporting, and an auditor is REQUIRED to detect them when the client is vulnerable. c) The auditor is REQUIRED to plan the audit to detect these factors when new employees are hired. d) The auditor is NOT REQUIRED to plan the audit to discover these items, but SHOULD consider them in identifying the risks of material misstatement arising from misappropriation of assets if they come across them during the audit.
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