Chapter 7

Chapter 4 Management Fraud and Audit Risk

ACCT-4080

Chapter 3

1

1. Errors, Fraud, and Noncompliance 



Definitions Errors - unintentional Fraud (irregularities) - intentional Noncompliance with laws and regulations (Illegal acts)violations of the law Auditor’s responsibilities 

ACCT-4080

History Errors & Fraud: SAS 1, SAS 16, SAS 53, SAS 82, SAS 99 Illegal Acts: SAS 54

Chapter 3

2

1. Errors, Fraud, and Noncompliance (continued) 

Errors and Fraud (AU-C 240) 



design and conduct the audit to provide reasonable assurance that material errors and fraud will be discovered, and report the findings to appropriate parties

Noncompliance with laws and regulations (Illegal Acts) (AU-C 250)  

direct effect noncompliance — same indirect effect noncompliance —   

have general level of awareness and act on those discovered make inquiries carry out some procedures to identify noncompliance

Questions ACCT-4080

Chapter 3

3

1. Errors, Fraud, and Noncompliance (continued) Steps involved in Considering the Risk of Fraud • Staff discussion • Obtain information needed to identify risks • Identify risks • Assess identified risks • Respond to results of assessment • Evaluate audit evidence • Communicate about fraud • Document consideration of fraud Chapter 6

4

2. Fraud Causes of Misstatements Causes Errors

Fraud

Misappropriation of Assets ACCT-4080

Chapter 3

Fraudulent Financial Reporting 5

2. Fraud (continued) EXHIBIT 3.1

ACCT-4080

Chapter 3

6

2. Fraud (continued) 

Fraudulent financial reporting (cooking the books) (management fraud)  



falsification of financial statements falsification or omissions of transactions

Misappropriation of assets (employee fraud)  

ACCT-4080

larceny embezzlement Chapter 3

7

2. Fraud (continued) 

Overview of Fraud (outline)      

ACCT-4080

costs discovery victims perpetrators common characteristics types Chapter 3

8

The Fraud Triangle PRESSURE

PERCEIVED OPPORTUNITY ISU WU

RATIONALIZATION Summer 2009

9

2. Fraud (continued)      

Prevalence of fraud Current frauds Reasons to study fraud Fraud related job opportunities ACFE CFE

ACCT-4080

Chapter 3

10

3. Audit Risk

ACCT-4080

Chapter 3

11

3. Audit Risk    

AU-C 320 – Audit Risk General business risks Engagement risk Audit Risk Model   



AR = RMM x DR AR = IR x CR x DR AR = IR x CR x TD x AP

Audit Risk definition 





ACCT-4080

the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated the danger that the auditor will fail to detect material misstatements in the financial statements at financial statement level; at account balance level Chapter 3

12

3. Audit Risk (continued) 

Risk of Material Misstatement  



Inherent Risk 





product of inherent risk and control risk consider at entity level and account/assertion level the susceptibility of an account balance to error assuming there are no controls based on auditor’s judgment considering understanding of entity, nature of account (routine, systematic processing, complexity, etc), and fraud considerations

Control Risk 



ACCT-4080

the risk that the ICS will not prevent or detect a material error on a timely basis based on tests of control’s effectiveness Chapter 3

13

3. Audit Risk (continued) 

Detection Risk 





the risk that the auditor’s procedures will not detect a material error the product of Tests of Details Risk (TD) and Substantive Analytical Procedures Risk (AP) Tests of Details Risk 



Substantive Analytical Procedures Risk 

ACCT-4080

the risk that tests of details will not detect a material error

the risk that analytical procedures (or other procedures that do not utilize sampling) will not detect a material error Chapter 3

14

3. Audit Risk (continued)   

Risks defined in negative Auditor’s control over risks Relationship between  

ACCT-4080

RMM and DR DR and amount of substantive testing

Chapter 3

15

3. Audit Risk (continued)  

Subjectively considering Audit Risk Quantifying Audit Risk  



not required DR = AR / IR x CR TD = AR / IR x CR x AP

Questions ACCT-4080

Chapter 3

16

3. Audit Risk (continued) 

General guidelines 

Inherent Risk 

 



Control Risk     

ACCT-4080

High > 60% Moderate 40% - 60% Low < 40% Maximum High Moderate Low Very Low

= 100% > 70% 40% - 70% < 40% < 10% Chapter 3

17

3. Audit Risk (continued) 

Analytical Procedures Risk    

ACCT-4080

High > 50% Moderate 20% - 50% Low 10% - 20% Very Low < 10%

Chapter 3

18

4. Analytical Procedures  

Definition Uses in an audit  





planning stage as a substantive test (SAP) final review stage

Required use

ACCT-4080

Chapter 3

19

4. Analytical Procedures (Continued) 

In planning stage 

  

ACCT-4080

enhances auditor’s understanding identifies risk areas uses highly aggregated data generally financial data

Chapter 3

20

4. Analytical Procedures (Continued) Steps



1. 2. 3.

4. 5.

ACCT-4080

develop an expectation define a significant difference calculate predictions and compare with recorded amount investigate significant differences document each step Chapter 3

21

4. Analytical Procedures (Continued) 

Substantive analytical procedures 

 



ACCT-4080

based on level of DR based on auditor judgment balance sheet data vs. income statement data often uses non-financial data Chapter 3

22

4. Analytical Procedures (Continued) 

In final evaluation stage 

 

uses aggregated data usually financial data review same data used in planning stage

Questions

ACCT-4080

Chapter 3

23

5. Review Questions for Discussion 

Chapter 4 4.6 4.7 4.8 4.9 4.12

ACCT-4080

4.14 4.17

Chapter 3

24