Chapter 11

Considering the
Risk of Fraud

Copyright 2014 Pearson Education

Define fraud and distinguish between

fraudulent financial reporting and
misappropriation of assets.
Describe the fraud triangle and identify
conditions for fraud.
Understand the auditors responsibility for
assessing the risk of fraud and detecting
material misstatements due to fraud.
Prepare the post-closing trial balance
11-2

Copyright 2014 Pearson Education

Identify corporate governance and other

control environment factors that reduce
fraud risks.
Develop responses to identified fraud risks.
Recognize specific fraud risk areas and
develop procedures to detect fraud.
Understand interview techniques and other
activities after fraud is suspected.
11-3

Copyright 2014 Pearson Education

1
Define fraud and distinguish
between fraudulent financial
reporting and misappropriation of
assets.
11-4

Copyright 2014 Pearson Education

Management
Fraud

Fraudulent
financial
reporting

11-5

Misappropriation
of assets

Copyright 2014 Pearson Education

2
Describe the fraud triangle and identify conditions
for fraud.

11-6

Copyright 2014 Pearson Education

Incentives/Pressures

Opportunities
11-7

Attitudes/Rationalization
Copyright 2014 Pearson Education

11-8

Copyright 2014 Pearson Education

Incentives/Pressures:
Financial stability or profitability is threatened by
economic, industry, or entity operating conditions
Excessive pressure exists for management to
meet debt requirements
Personal net worth is materially threatened

11-9

Copyright 2014 Pearson Education

Opportunities:
There are significant accounting estimates that
are difficult to verify
There is ineffective oversight over financial
reporting
High turnover or ineffective accounting, internal
audit, or information technology staff exists
11-10

Copyright 2014 Pearson Education

Attitudes/Rationalization:
Inappropriate or inefficient communication
and support of the entitys values is evident
A history of violations of laws is known
Management has a practice of making
overly aggressive or unrealistic forecasts

11-11

Copyright 2014 Pearson Education

Incentives/Pressures:
Personal financial obligations create pressure
to misappropriate assets
Adverse relationships between management
and employees motivate employees to
misappropriate assets

11-12

Copyright 2014 Pearson Education

Opportunities:
There is a presence of large amounts of cash
on hand or inventory items
There is an inadequate internal control over
assets

11-13

Copyright 2014 Pearson Education

Attitudes/Rationalization:
Disregard for the need to monitor or reduce
risk of misappropriating assets exists
There is a disregard for internal controls

11-14

Copyright 2014 Pearson Education

3
Understand the auditors responsibility for
assessing the risk of fraud and detecting
material misstatements due to fraud.

11-15

Copyright 2014 Pearson Education

Auditing standards provide guidance to

Auditors in assessing the risk of fraud.

Auditing standards state that, in exercising

Professional skepticism, an auditor
neither assumes that management is
dishonest nor assumes unquestioned honesty.

11-16

Copyright 2014 Pearson Education

11-17

Copyright 2014 Pearson Education

 Discussion among engagement team

Procedures performed to assess risk
Specific risks and audit response
Reasons supporting conclusions
Results of procedures performed
Other conditions and analytical
relationships
Nature of communications

11-18

Copyright 2014 Pearson Education

4
Identify corporate governance and
other control environment factors
that reduce fraud risks.

11-19

Copyright 2014 Pearson Education

1. Culture of honesty and high ethics

2. Management's responsibility
to evaluate risks of fraud
3. Audit committee oversight

11-20

Copyright 2014 Pearson Education

 Organizational code of conduct

General employee conduct
Conflicts of interest
Outside activities, employment, and
directorships

11-21

Copyright 2014 Pearson Education

 Relationships with clients and suppliers

Gifts, entertainment, and favors
Kickbacks and secret commissions
Organization funds and other assets

11-22

Copyright 2014 Pearson Education

 Organization records and communications

Dealing with outside people and
organizations
Prompt communications
Privacy and confidentiality

11-23

Copyright 2014 Pearson Education

11-24

Copyright 2014 Pearson Education

5
Develop responses to identified
fraud risks.

11-25

Copyright 2014 Pearson Education

Change the overall conduct of the audit

to respond to identified fraud risks.
Design and perform audit procedures
to address fraud risks.
Design and perform procedures to
address the risk of management
override of controls.
11-26

Copyright 2014 Pearson Education

6
Recognize specific fraud risk areas and
develop procedures to detect fraud.

11-27

Copyright 2014 Pearson Education

 Revenue and accounts receivable fraud risks

Inventory fraud risks
Purchases and accounts payable fraud risks
Other areas of fraud risk

11-28

Copyright 2014 Pearson Education

11-29

Copyright 2014 Pearson Education

11-30

Copyright 2014 Pearson Education

11-31

Copyright 2014 Pearson Education

11-32

Copyright 2014 Pearson Education

Informational
Assessment
Listening

Evaluating
responses
Interrogative

Observing
behavioral cues
11-33

Copyright 2014 Pearson Education

11-34

Copyright 2014 Pearson Education

11-35

Copyright 2014 Pearson Education

11-36

Copyright 2014 Pearson Education

Copyright

All rights reserved. No part of this publication may

be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise,
without the prior written permission of the
publisher. Printed in the United States of America.
11-37

Copyright 2014 Pearson Education