Chapter 11 - Fraud Auditing

By Cynthia Olson,2014-05-15 15:54
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Chapter 11 - Fraud Auditing

    Chapter 11 - Fraud Auditing

? Multiple Choice Questions From CPA Examinations

11-20 a. (3) b. (4) c. (1) d. (2)

11-21 a. (1) b. (4)

11-22 a. (1) b. (1) c. (1)


     Information Fraud Condition

    1. Management has a strong interest in employing

    inappropriate means to minimize reported Incentives/Pressures

    earnings for tax-motivated reasons.

    2. Assets and revenues are based on significant Opportunities estimates that involve subjective judgments and

    uncertainties that are hard to corroborate.

    3. The company is marginally able to meet Incentives/Pressures exchange listing and debt covenant


    4. Significant operations are located and conducted Opportunities across international borders in jurisdictions

    where differing business environments and

    cultures exist.

    5. There are recurring attempts by management to Attitudes/Rationalization justify marginal or inappropriate accounting on

    the basis of materiality.

    6. The company’s financial performance is Incentives/Pressures threatened by a high degree of competition and

    market saturation.


    a. Management fraud is often called fraudulent financial reporting, and is the

    intentional misstatement or omission of amounts or disclosures by management

    with the intent to deceive users. In contrast, defalcations, which are also called

    misappropriation of assets, involve theft of an entity’s assets, and normally

    involve employees and others below the management level.

    b. The auditor’s responsibility to detect management fraud is the same as for other

    errors that affect the financial statement. The auditor should design the audit to

    obtain reasonable assurance that material misstatements in the financial

    statements due to errors or fraud are detected.

    c. The auditor should evaluate the potential for management fraud using the fraud

    triangle of incentives/pressures, opportunities, and attitudes/ rationalizations.

    ? Incentives/pressures Auditors should evaluate incentives and pressures

    that management or other employees may have to misstate financial

    statements, including:

    1. Declines in the financial stability or profitability of the company due to

    economic, industry, or company operating conditions.

    2. Pressure to meet debt repayment or debt covenant terms.

    3. Net worth of managers or directors is materially threatened by financial


    ? Opportunities Circumstances provide an opportunity for management to

    misstate financial statements, such as:

    1. Financial statements include significant accounting estimates that

    are difficult to verify.

    2. Ineffective board of director or audit committee oversight.

    3. High turnover in accounting personnel or ineffective accounting,

    internal auditing, or IT staff. ? Attitudes/Rationalizations An attitude, character, or set of values exist

    that allows management to rationalize committing a dishonest act.

    1. Inappropriate or ineffective communication of entity values.

    2. History of violations of securities laws or other laws and


    3. Aggressive or unrealistic management goals or forecasts.

    d. There are potentially many factors that should heighten an auditor’s concern

    about the existence of management fraud. The factors (1) of an intended public

    placement of securities, and (2) management compensation dependent on

    operating results are both factors that affect incentives to manipulate financial

    statements. The auditor should be alert for other incentives, such as the

    existence of debt covenants or planned use of stock to acquire another company

    that may provide incentives to manipulate the financial statements.

    11-24, continued

     The third factor of weak internal control reflects both an opportunity to

    misstatement financial statements, and an attitude that allows rationalization of

    actions to misstate the financial statements. As additional examples, the auditor

    should be alert to the potential to use accounting estimates or discretion over the

    timing of revenues to misstate financial statements. The auditor should also

    consider the attitude of management, and whether they are overly aggressive or

    have previously violated securities laws or other regulations.

     In addition to the risk factors from the fraud triangle, the auditor should

    consider other signals of the potential existence of management fraud. These

    signals may include unusual changes in ratios or other performance measures,

    as well as inquiries of management and communication amount the audit team.

11-25. a.

    DEFICIENCY RECOMMENDATION 1. There is no basis for Prenumbered admission tickets should be issued upon

    establishing the documentation payment of the admission fee.

    of the number of paying


    2. There is no segregation of One clerk (hereafter referred to as the cash receipts

    duties between persons clerk) should collect admission fees and issue

    responsible for collecting prenumbered tickets. The other clerk (hereafter

    admission fees and persons referred to as the admission clerk) should authorize

    responsible for authorizing admission upon receipt of the ticket or proof of

    admission. membership.

    3. An independent count of paying The admission clerk should retain a portion of the

    patrons is not made. prenumbered admission ticket (admission ticket stub).

    4. There is no proof of accuracy of Admission ticket stubs should be reconciled with cash

    amounts collected by the clerks. collected by the treasurer each day. 5. Cash receipts records are not The cash receipts should be recorded by the cash

    promptly prepared. receipts clerk daily on a permanent record that will

    serve as the first record of accountability. 6. Cash receipts are not promptly Cash should be deposited at least once each day.

    deposited. Cash should not be

    left undeposited for a week.

    7. There is no proof of the Authenticated deposit slips should be compared with

    accuracy of amounts deposited. daily cash receipts records. Discrepancies should be

    promptly investigated and resolved. In addition, the

    treasurer should establish policy that includes a review

    of cash receipts. 8. There is no record of the The treasurer should issue a signed receipt for all

    internal accountability for cash. proceeds received from the cash receipts clerk. These

    receipts should be maintained and should be

    periodically checked against cash receipts and deposit


b. All of the deficiencies increase the likelihood of misappropriation of assets, by allowing

    individuals access to cash receipts or failing to maintain adequate records to establish

    accountability for cash receipts.

    c. The deficiencies have less of an effect on the likelihood of fraudulent financial reporting

    than they do for misappropriation of assets. The first four deficiencies increase the

    likelihood of fraudulent financial reporting for reported revenues due to the lack of

    adequate records to establish the number of patrons.

11-29 a. The auditor must conduct the audit to detect errors and fraud, including

    embezzlement, that are material to the financial statements. It is more difficult to

    discover embezzlements than most types of errors, but the auditor still has

    significant responsibility. In this situation, the deficiencies in internal control are

    such that it should alert the auditor to the potential for fraud. On the other hand,

    the fraud may be immaterial and therefore not be of major concern. The auditor

    of a public company must also consider the impact of noted deficiencies when

    issuing the auditor’s report on internal control over financial reporting. When

    noted deficiencies are considered to be material weaknesses, whether

    individually or combined with other deficiencies, the auditor’s report must be

    modified to reflect the presence of material weaknesses.

     b. The following deficiencies in internal control exist:

     1. The person who reconciles the bank account does not compare payees

    on checks to the cash disbursements journal.

     2. The president signs blank checks, thus providing no control over


     3. No one checks invoices to determine that they are cancelled when paid.

     c. To uncover the fraud, the auditor could perform the following procedures:

     1. Comparison of payee on checks to cash disbursements journal.

    2. Follow up all outstanding checks that did not clear the bank during the

    engagement until they clear the bank. Compare payee to cash

    disbursements journal.

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