Acfn 723 Chapter 8 - 2019

Acfn 723: Advanced Auditing
Addis Ababa University

College of Business and Economics
Department of Accounting & Finance
• Module Title: Advanced Auditing

• Module Code: ACFN 723
• Credit Value: 2 Cr hours [4.5 ECTS]
• Instructor: Dr. P. Laxmikantham
Acfn 723: Advanced Auditing/PLK

Chapter 8
Fraud Auditing

Fraud Auditing - contents
• Categories of fraud, three conditions for fraud
• Risk factors for each condition of fraud for fraudulent financial
reporting
• The sources of information to assess fraud risks
• Components of a code of conduct: general employee conduct,
relationships with clients & suppliers and conflicts of interest
• Senior management’s responsibility for promoting a culture of
honesty and ethics
• Types of revenue manipulations
• Types of inquiry

Fraud
• Define fraud and distinguish between the two main categories of
fraud.
• In the context of financial statement auditing, fraud is defined as an
intentional misstatement of the financial statements.
• The two main categories of fraud are:
– fraudulent financial reporting and
– misappropriation of assets.
Fraudulent financial reporting is an intentional misstatement or
omission of amounts or disclosures with the intent to deceive
users of the financial statements.
Misappropriation of assets involve theft of an entity's assets.

Define fraud and distinguish
between fraudulent financial
reporting and misappropriation of assets.

Management
Fraud
Fraudulent
Misappropriation
financial
of assets
reporting

Describe the fraud triangle and identify
conditions for fraud.

Incentives/Pressures
Opportunities Attitudes/Rationalization

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

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

Attitudes/Rationalization:
 Inappropriate or inefficient communication
and support of the entity’s values is evident
 A history of violations of laws is known
 Management has a practice of making

overly aggressive or unrealistic forecasts

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

and employees motivate employees to
misappropriate assets

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

assets

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

Understand the auditor’s responsibility for
assessing the risk of fraud and detecting
material misstatements due to fraud.

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.”

 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

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

1.Culture of honesty and high ethics
2. Management's responsibility
to evaluate risks of fraud
3. Audit committee oversight

Culture of honesty and ethics
• Senior management is responsible for promoting a culture of honesty and ethics.
• Management cannot act one way and expect others in the company to behave
differently.
• Through its actions and communications, management can show that dishonest
or unethical behavior is not tolerated, even if the results benefit the company.
• For example, statements by management about the absolute need to meet
operating and financial targets create undue pressures that may lead employees
to commit fraud to achieve them.
• In contrast, statements indicating management's desire to aggressively pursue
the entity's goals and targets while at the same time requiring honest and ethical
actions to achieve those goals, clearly indicates to employees that integrity is a
requirement.
• Whichever course management pursues, its actions establish the "tone at the
top."

 Organizational code of conduct
 General employee conduct
 Conflicts of interest
 Outside activities, employment, and

directorships

 Relationships with clients and suppliers
 Gifts, entertainment, and favors
 Kickbacks and secret commissions
 Organization funds and other assets

 Organization records and communications
 Dealing with outside people and

organizations
 Prompt communications
 Privacy and confidentiality

Code of conduct
• General employee conduct—Employees should conduct themselves
in a businesslike manner and prohibit unprofessional activities such
as drinking, gambling, fighting, and swearing, while on the job.
• Relationships with client and suppliers—Employees should avoid
investing in or acquiring a financial interest in any business
organization that has a contractual relationship with the
organizations.
• Conflicts of Interest—Employees are expected to perform their
duties conscientiously, honestly, and in accordance with the best
interests of the organization and to not use their positions or
knowledge gained for private or personal advantage.

Develop responses to identified
fraud risks.

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.

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

 Revenue and accounts receivable fraud risks
 Inventory fraud risks
 Purchases and accounts payable fraud risks
 Other areas of fraud risk

Three main types of revenue
manipulations
The three main types of revenue manipulation are:
• Fictitious revenues — preparation of fictitious documentary
evidence for sales and reduction of inventory.
• Premature revenue recognition — bill and hold; side
agreements; unlimited right of return.
• Manipulation of adjustments to revenues — adjustments to
the sales and returns allowance account, i.e., not recording
returns; also, understating the estimate for bad debts which
reduces the bad debt expense and understates the allowance
for doubtful accounts.

Types of inquiry techniques
• There are three main types of inquiry available for use by auditors.
These are
– informational inquiry,
– assessment inquiry, and
– interrogative inquiry.
Informational inquiry is used to obtain information about facts and details that
the auditor does not have.
Assessment inquiry is used to corroborate or contradict prior information.
Interrogative inquiry is often used when the auditor seeks responses from an
individual about his or her knowledge of an event or circumstances. It is
often used to determine if the individual is being deceptive or purposely
omitting disclosure of key knowledge of facts, events, or circumstances. This
type of inquiry is often confrontational in nature.

Understand interview techniques and
other activities after fraud is suspected.

Informational
Assessment
Listening
Evaluating
responses
Interrogative
Observing
behavioral cues

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Acfn 723: Advanced Auditing

Addis Ababa University

• Module Title: Advanced Auditing

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

 Excessive pressure exists for management to

 Personal net worth is materially threatened

Acfn 723: Advanced Auditing/PLK

 There is ineffective oversight over financial

 High turnover or ineffective accounting, internal

Acfn 723: Advanced Auditing/PLK

 A history of violations of laws is known

 Management has a practice of making

Acfn 723: Advanced Auditing/PLK

 Adverse relationships between management

Acfn 723: Advanced Auditing/PLK

 There is an inadequate internal control over

Acfn 723: Advanced Auditing/PLK

 There is a disregard for internal controls

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Auditing standards state that, in exercising

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

3. Audit committee oversight

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

 General employee conduct

 Outside activities, employment, and

Acfn 723: Advanced Auditing/PLK

 Gifts, entertainment, and favors

 Kickbacks and secret commissions

 Organization funds and other assets

Acfn 723: Advanced Auditing/PLK

 Dealing with outside people and

 Privacy and confidentiality

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Design and perform audit procedures

Design and perform procedures to

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

 Inventory fraud risks

 Purchases and accounts payable fraud risks

 Other areas of fraud risk

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

Acfn 723: Advanced Auditing/PLK

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