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Chapter 7

CHAPTER 7.docx

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Department
Accounting
Course Code
ACC 521
Professor
Kathryn Bewley

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CHAPTER 7: FRAUD RISK ASSESSMENT Definitions related to fraud White collar crimes: Misdeeds committed by business and government professionals, typically non-violent Fraud: In financial statement auditing, and intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage Two types of fraud include: 1) Employee fraud: The use of dishonest means to take money or other property from an employer Three phases of employer fraud include: 1) The fraudulent act 2) The conversion of money or property to fraudster’s use 3) The cover up 2) Embezzlement: fraud involving employees or non-employees wrongfully taking money or property entrusted to their care/control; often accompanied by false accounting entries and other forms of lying and cover-up Defalcation: Fraud in which an employee takes assets from organization for personal gain; may be due to corruption or assets misappropriation Fraudulent financial reporting: Intentional manipulation of reported financial results to portray a misstated economic picture of the firm by which the perpetrator seeks an increase in personal wealth gain through a rise in stock price or compensation Error: in financial statement auditing, unintentional misstatement or omission of amounts or disclosures in financial statements Misappropriation of assets: The theft or misuse of an organization’s assets Fraud also includes the following: 1) Use of deception, such as manipulation, falsification, or alteration of accounting records or documentations 2) Misrepresentation or intentional omission of events, transactions, or other significant information 3) Intentional misapplication of accounting principles relating to amount, classification, or manner of presentation of disclosures Illegal act: in financial statement auditing, non-compliance with a domestic, or foreign statutory law or government regulation attributable to the entity under audit, or to management or employees acting on the entity’s behalf this does not include personal misconduct by the entity’s management or employees unrelated to the entity’s business activities. Auditor’s responsibilities for detecting fraud • Auditors have the responsibility to obtain reasonable assurance as to whether the financial statements are free of material misstatements, including misstatements due to fraud. Auditors’ responsibility to consider fraud and error in an audit of financial statements Fraud risk: in financial statement auditing, the possibility that fraud has resulted in intentional misstatement in the financial statements TWO types of intentional misstatements are relevant to the auditor: 1) those resulting from fraudulent financial reporting 2) Those resulting from misappropriation of assets. • The auditors should document fraud risk factors identified as being present during the auditor’s assessment process and document the their response to the assessed risks of material misstatement due to fraud at the financial statement level o Includes: nature, timing and extent of audit procedures and how the procedures link to with the assessed fraud risks at the assertion level • The auditor should obtain written management representation about management’s suspicions or knowledge of any actual fraud and its extent. • CAS 240 makes it clear that the primary responsibility for the prevention and detection of fraud rests with management o They are responsible for designing and implementing internal controls and other corporate governance mechanisms to deter fraud • CAS 240 requires auditors to maintain professional skepticism and make no assumptions about management’s honesty • CAS 240 rebuttable presumptions require auditors to perform analytical procedures on revenues, make enquiries, and scan for unusual entries, and the audit team should have brainstorming sessions to identify and share information on fraud risk factors. Illegal acts by auditees Direct-effect illegal acts: Violations of laws or government regulations by the company, its management, or the employees that produce direct and material effects on dollar amounts in financial statements Indirect-effect illegal acts: Violations of laws and regulations that are far removed from financial statements • CAS250 acknowledges that illegal acts may be difficult to detect because of: o Efforts made to conceal them o Questions about whether an act is illegal • CAS 250 states that material possibly illegal acts should be communicated to the audit committee and appropriate levels of management Auditing accounting estimates and fair value accounting • CAS 540 deals with estimation of uncertainty and the need to address significant risks associated with this uncertainty by ensuring that they are adequately disclosed Communication with audit committees (or equivalent) • CAS260 requires those charged with governance to be informed about the scope and results of the independent audit • CAS requires oral/written communications from auditors on the following: o Misstatement other than trivial errors o Fraud o Misstatements that may false future financial statements to be materially misstated o Illegal or possibly illegal acts, other than those determined inconsequential o Significant weaknesses to internal control • CAS 240 states that an auditor is responsible for obtaining reasonable assurance whether the financial statements are free of material misstatements without qualifying the sources of that misstatement. According to CAS 240, auditors must document the following: 1) Discussion among audit team members regarding the auditee entity’s susceptibility to fraudulently misstated financial statements, including how and when the discussion occurrence, who participated and the subjects discussed 2) Procedures to identify and assess the risk 3) Specific risks identified and a description of the auditor’s response to those risks 4) Reasons supporting that conclusion, unless a particular improper revenue recognition has been identified 5) Results of procedures performed to address the risk of management override of controls 6) Conditions and analytical relationships causing the auditor to believe additional auditing procedures were required and any further responses deemed appropriate to addressing such risks 7) Nature of communications about fraud made to management the audit committee and oth
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