Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users. Two examples of fraudulent financial reporting are accelerating the timing of recording sales revenue to increased reported sales and earnings, and recording expenses as fixed assets to increase earnings.
Misappropriation of assets is fraud that involves theft of an entity’s assets. Two examples are an accounts payable clerk issuing payments to a fictitious company controlled by the clerk, and a sales clerk failing to record a sale and pocketing the cash receipts.
Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users, while misappropriation of assets is fraud that involves theft of an entity’s assets. Frauds involving financial reporting are usually larger than frauds involving misappropriation of assets, usually involve top management, and do not directly involve theft of company assets.
The three conditions of fraud referred to as the “fraud triangle” are (1) Incentives/Pressures; (2) Opportunities; and (3) Attitudes/Rationalization. Incentives/Pressures are incentives of management or other employees to commit fraud. Opportunities are circumstances that allow management or employees to commit fraud. Attitudes/Rationalization are indications that an attitude, character, or set of ethical values exist that allow management or employees to commit a dishonest act or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act.
The following are example of risk factors for fraudulent financial reporting for each of the three fraud conditions:
Incentives/Pressures - The company is under pressure to meet debt covenants or obtain additional financing.
Opportunities – Ineffective oversight of financial reporting by the board of directors allows management to exercise discretion over reporting.
Attitudes/Rationalization – Management is overly aggressive. For example, the company may issue aggressive earnings forecasts, or make extensive acquisitions using company stock.
The following are example of risk factors for misappropriation of assets for each of the three fraud conditions:
Incentives/Pressures - The individual is unable to meet personal financial obligations.
Opportunities – There is insufficient segregation of duties that allows the individual to handle cash receipts and related accounting records.
Attitudes/Rationalization – Management has disregarded the inadequate separation of duties that allows the potential theft of cash receipts.
Auditors use several sources to gather information about fraud risks, including:
Information obtained from communications among audit team members about their knowledge of the company and its industry, including how and where the company might be susceptible to material misstatements due to fraud.
Responses to auditor inquiries of management about their views of the risks of fraud and about existing programs and controls to address specific identified fraud risks.
Specific risk factors for fraudulent financial reporting and misappropriations of assets.
Analytical procedures results obtained during planning that indicate possible implausible or unexpected analytical relationships.
Knowledge obtained through other procedures such as client acceptance and retention decisions, interim review of financial statements, and consideration of inherent or control risks.
SAS 99 requires the audit team to conduct discussions to share insights from more experienced audit team members and to “brainstorm” ideas that address the following:
How and where they believe the entity’s financial statements might be susceptible to material misstatement due to fraud. This should...
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