Fraud Risk Assessment Simulator
An auditor must plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
Understanding Fraud
Fraudulent Financial Reporting
Intentional misstatements or omissions designed to deceive financial statement users. This is often called "cooking the books" and is usually committed by management.
- Manipulation of accounting records
- Misrepresentation of events or transactions
- Intentional misapplication of GAAP
Misappropriation of Assets
Theft of an entity's assets (defalcation) where the effect of the theft causes the financial statements to be materially misstated.
- Embezzling receipts
- Stealing physical assets or intellectual property
- Causing the company to pay for goods not received
The Fraud Triangle
Three conditions, known as fraud risk factors, are generally present when fraud occurs. The risk is greatest when all three are present.
Auditor's Required Response to Assessed Fraud Risks
Overall, General Response
The auditor must respond to overall fraud risk by adjusting how the audit is conducted:
- Assigning Personnel: Assign more experienced staff or specialists to the engagement.
- Supervision: Determine the appropriate level of supervision for the engagement team.
- Accounting Principles: Evaluate management's selection and application of accounting principles for potential bias.
- Unpredictability: Incorporate an element of unpredictability in the selection of audit procedures from year to year (e.g., surprise inventory counts).
Response with Specific Audit Procedures
The auditor must design and perform audit procedures whose nature, timing, and extent are responsive to the specific fraud risks identified for each relevant assertion.
- Nature: Change the type of procedures to obtain more reliable evidence (e.g., use external confirmations instead of internal inquiries).
- Timing: Perform procedures closer to year-end or throughout the period.
- Extent: Increase sample sizes or perform more extensive analytical procedures.
Response to Management Override Risk
There is a presumptive risk of management override of controls in every audit. The auditor must perform these specific procedures:
- Journal Entries: Examine journal entries and other adjustments for evidence of possible material misstatement due to fraud. Focus on nonstandard or unusual entries.
- Accounting Estimates: Review accounting estimates for biases. Perform a retrospective review by comparing prior-period estimates to actual results.
- Unusual Transactions: Evaluate the business purpose (or lack thereof) for significant unusual transactions to see if they are designed to conceal fraud.
