chapter 10
What three auditor actions are required to address the potential for management override of controls?
Auditors are required to take three actions to address potential management override of controls: (1) examine journal entries and other adjustments for evidence of possible misstatements due to fraud; (2) review accounting estimates for biases; and (3) evaluate the business rationale for significant unusual transactions.
Give examples of risk factors for fraudulent financial reporting for each of the three fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization.
Incentives/pressures- the company is under pressure to meet debt covenants or obtain additional financing Opportunities- ineffective oversight of financial reporting by the bod allows management to exercise discretion over reporting Attitudes/rationalization - management is overly aggressive for example the company may issue aggressive earnings forecasts or make extensive acquisitions using company stock
Define misappropriation of assets and give two examples of misappropriation of assets.
Misappropriation of assets is fraud that involves theft of an entity's assets. Two examples are an accounts payable clerk issuing payments to a fictitious company controlled by the clerk, and a sales clerk failing to record a sale and pocketing the cash receipts.
Describe the types of information that should be included in the auditor's working papers as evidence of the auditor's fraud assessment procedures.
-procedures performed to obtain information necessary to identify and assess the risk of material fraud. -specific risks of material fraud that were identified at both the overall fs level and the assertion level and the description of the auditor's responses to those risks. -reasons supporting a conclusion that there is not a significant risk of material improper revenue recognition. -results of the procedures performed to address the risk of management override of controls. -the nature of communications about fraud made to management, the audit committee, or others
What should the audit team consider in its planning discussion about fraud risks?
Auditing standards require the audit team to conduct discussions to share insights from more experienced audit team members and to "brainstorm" ideas that address the following: 1. How and where they believe the entity's fs might be susceptible to material misstatement due to fraud. This should include consideration of known external and internal factors affecting the entity that might -create an incentive or pressure for management to commit fraud -provide provide the opportunity for fraud to be perpetrated -indicates a culture or environment that enables management to rationalize fraudulent acts 2. How management could perpetrate and conceal fraudulent financial reporting. 3. How assets of the entity could be misappropriated 4. How the auditor might respond to the susceptibility of material misstatements due to fraud
Auditors are required to make inquiries of individuals in the company when gathering information to assess fraud risk. Identify those with whom the auditor must make inquiries.
Auditors must inquire whether management has knowledge of any fraud or suspect fraud within the company. Auditing standards also require auditors to inquire of the audit committee about its views of the risks of fraud and whether the audit committee has knowledge of any fraud or suspected fraud. If the entity has an internal audit function, the auditor should inquire about internal audit's views of fraud risks and whether they have performed any procedures to identify or detect fraud during the year. Auditing standards further require the auditor to make inquiries of others within the entity whose duties lie outside the normal financial reporting lines of responsibility about the existence or suspicion of fraud
Define fraudulent financial reporting and give two examples that illustrate fraudulent financial reporting.
Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users. Two examples are accelerating the timing of recording sales revenue to increase reported sales and earnings, and recording expenses as fixed assets to increase earnings
Give risk factors for misappropriation of assets for each of the three fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization.
Incentives/pressures- the individual is unable to meet personal financial obligations Opportunities-there is insufficient segregation of duties that allows the individual to handle cash receipts and related accounting records Attitudes/rationalization-management has disregarded the inadequate separation of duties that allows the potential theft of cash receipts
Discuss the importance of the control environment, or "setting the tone at the top," in establishing a culture of honesty and integrity in a company.
Management and the board of directors are responsible for setting the "tone at the top" for ethical behavior in the company. It is important for management to behave with honesty and integrity because this reinforces the importance of these values to employees through the organization.
Distinguish managements responsibility from the audit committee's responsibility for designing and implementing antifraud programs and controls within a company.
Management has primary responsibility to design and implement antifraud programs and controls to prevent, deter, and detect fraud. The audit committee has primary responsibility to oversee the organization's financial reporting and internal control processes and to provide oversight of management's fraud risk assessment process and antifraud programs and controls.
The two components of professional skepticism are a questioning mind and a critical assessment of the audit evidence. How do these components help an auditor distinguish an unintentional misstatement from an intentional (fraudulent) misstatement?
Professional skepticism suggest the auditor should neither assume that management is dishonest, nor assume unquestioned honestly, and an auditor should remain professionally skeptical throughout the entire audit process. A questioning mind will encourage the auditor to gather more persuasive evidence to corroborate management responses, which would help the auditor distinguish intentional from unintentional misstatements. Critically assessing the evidence means the auditor evaluates each piece of evidence separately, but also evaluates all of the evidence gathered as a whole. For example, if all of management's estimates are biased in the direction of increasing net income, the auditor would be more likely to conclude the misstatements are intentional.
You go through the drive-through window at a fast food restaurant and notice a sign that reads, "Your meal is free if we fail to give you a receipt." Why would the restaurant post this sign?
Revenue and related accounts receivable and cash accounts are especially susceptible to manipulation and theft. Research finds that a majority of financial statement fraud instances involve revenues and accounts receivable. As a result of the frequency of financial reporting frauds involving revenue recognition, auditing standards require the auditor to presume fraud risk is present in revenue recognition in all audits. In light of this presumption, auditors should evaluate the types of revenue and revenue transactions, and the assertions related to these transactions, which may increase fraud risk.
Name the three categories of inquiry and describe the purpose of each when used by an auditor to obtain additional information about a suspected fraud.
The three types of inquiry are informational, assessment, and interrogative. Auditors use informational inquiry to obtain information about facts and details that the auditor does not have,. For example, if the auditor suspects financial statement fraud involving improper revenue recognition, the auditor may inquire of management as to revenue recognition policies. The auditor uses assessment inquiry to corroborate or contradict prior information. In the previous example, the auditor may attempt to corroborate the information obtained from management by making assessment inquiries of individuals in accounts receivable and shipping. Interrogative inquiry is used to determine if they interviewee is being deceptive or purposefully omitting disclosure of key knowledge of facts, events, or circumstances. For example, a senior member of the audit team might make interrogative inquiries of management or other personnel about key elements of the fraud where earlier responses were contradictory or evasive.
Identify three verbal and three nonverbal cues that may be observed when making inquiries of an individual who is being deceitful.
When making inquiries of a deceitful individual three examples of verbal cues are frequent rephrasing of the question, filler terms such as "Well" or "to tell the truth", and forgetfulness or acknowledgements of nervousness. Three examples of nonverbal cues by the individual are creating physical barriers by blocking their mouth, leaning away from the auditor, and signs of stress such as sweating or fidgeting.
