copyright © 2016 south-western/cengage learning the auditor’s responsibilities regarding fraud...

Copyright © 2016 South-Western/Cengage Learning

THE AUDITOR’S RESPONSIBILITIES REGARDING FRAUD AND MECHANISMS TO ADDRESS FRAUD: REGULATION

AND CORPORATE GOVERNANCE

CHAPTER 2

AuditingA Risk-Based Approach To Conducting A Quality Audit

10th edition

Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg

Copyright © 2016 South-Western/Cengage Learning 2-2

LEARNING OBJECTIVES

1. Define the various types of fraud that affect organizations2. Define the fraud triangle and describe its three elements 3. Describe implications for auditors of recent fraudulent financial

reporting cases and the third COSO report on fraud4. Discuss auditors’ fraud-related responsibilities and users’ related

expectations5. Explain how various requirements in the Sarbanes–Oxley Act of

2002 are designed to help prevent the types frauds perpetrated in the late 1990s and early 2000s

6. Define corporate governance, identify the parties involved, and describe their respective activities


THE AUDIT OPINION FORMULATION PROCESS


DEFINE THE VARIOUS TYPES OF FRAUD THAT AFFECT ORGANIZATIONS

LEARNING OBJECTIVE 1


FRAUD

• An intentional act involving use of deception that results in a misstatement of financial statements• Two types of misstatements• Misappropriation of assets• Fraudulent financial reporting

• Different from errors • Errors occur unintentionally


ASSET MISAPPROPRIATION

• Involves theft or misuse of organization’s assets • Examples • Skimming cash • Stealing inventory • Payroll fraud

• A dominant fraud scheme perpetrated against small businesses• Perpetrators are commonly employees


FRAUDULENT FINANCIAL REPORTING

• The intentional manipulation of reported financial results to misstate the economic condition of the organization• Common ways • Manipulation, falsification, or alteration of accounting

records or supporting documents• Misrepresentation or omission of events or

transactions• Misapplication of accounting principles


DEFINE THE FRAUD TRIANGLE AND DESCRIBE ITS THREE ELEMENTS



EXHIBIT 2.2 - THE FRAUD TRIANGLE


INCENTIVES TO COMMIT FRAUD


OPPORTUNITIES TO COMMIT FRAUD


RATIONALIZING THE FRAUD

• Rationalization involves reconciling unlawful or unethical behavior• Rationalization for fraudulent financial reporting• “Saving” a company

• Rationalization for asset misappropriation• Mistreatment by the company • Sense of entitlement by the individual perpetrating the

fraud


DESCRIBE IMPLICATIONS FOR AUDITORS OF RECENT FRAUDULENT FINANCIAL REPORTING

CASES AND THE THIRD COSO REPORT ON FRAUD



IMPLICATIONS TO KEEP IN MIND WHEN CONDUCTING AN AUDIT

• Pressure created for top management by the analyst following and earnings expectations• Before completing an audit, sufficient time should be allowed

to examine major year-end transactions:• Especially if there are potential problems with revenue

• Understanding complex transactions to determine:• Their economic substance• The parties that have economic obligations

• Understanding and analyzing weaknesses in an organization’s internal controls


THE THIRD COSO REPORT - AN ANALYSIS

• Major findings• The amount and incidence of fraud remains high• The median size of company perpetrating the fraud rose

tenfold • Heavy involvement in fraud by the CEO and/or CFO• Most common fraud involved revenue recognition• One-third of the companies changed auditors during the

latter part of the fraud• Majority of the frauds took place at companies that

were listed on the Over-The-Counter (OTC) market


DISCUSS AUDITORS’ FRAUD-RELATED RESPONSIBILITIES

AND USERS’ RELATED EXPECTATIONS



MITIGATING THE RISK OF FRAUDULENT FINANCIAL REPORTING

• Center for Audit Quality recommends three ways in which individuals involved in the financial reporting process can mitigate risk of fraudulent reporting• Need to acknowledge the existence of a strong, highly

ethical tone at the top of an organization• Need to consistently exercise professional skepticism in

evaluating and/or preparing financial reports• Need to understand the role of strong communication

in the financial reporting process


MESSAGE TO AUDITORS

• Assume greater responsibility for detecting fraud• Provide assurance that financial statements are free

of material fraud


EXPLAIN HOW VARIOUS REQUIREMENTS IN THE SARBANES–OXLEY ACT OF 2002 ARE DESIGNED TO

HELP PREVENT THE TYPES FRAUDS PERPETRATED IN THE LATE 1990S AND EARLY 2000S



SARBANES-OXLEY ACT OF 2002

• Broad legislation mandating standard setting for audits of public companies and standards for corporate governance• Applies to publicly traded companies • Not privately held organizations

• Read Exhibit 2.4 carefully to understand the sections of SOX and the various features of the legislation


DEFINE CORPORATE GOVERNANCE, IDENTIFY THE PARTIES INVOLVED, AND DESCRIBE THEIR

RESPECTIVE ACTIVITIES



CORPORATE GOVERNANCE

• A process by which owners and creditors exert control and require accountability for resources entrusted to organizations• Owners elect board of directors to provide: • Oversight of organizations’ activities• Accountability to stakeholders


EXHIBIT 2.5 - OVERVIEW OF CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES


PARTIES INVOLVED IN CORPORATE GOVERNANCE

• Board of directors: The major representative of stockholders, who ensure that the organization is run according to the organization’s charter and that there is proper accountability• Audit committee: A subcommittee of the board of

directors responsible for monitoring audit activities and serving as a surrogate for the interests of shareholders


PARTIES INVOLVED IN CORPORATE GOVERNANCE

• Board of directors and its audit committee oversee management• Expected to protect stockholders’ rights• Ensure that controls exist to prevent and detect fraud

• Stakeholders: Anyone who is influenced, either directly or indirectly, by actions of a company


RESPONSIBILITIES OF AUDIT COMMITTEES

• Appointment, compensation, and oversight of work of audit firms• Must be independent• Establish whistleblowing mechanisms within

companies• Authority to engage their own independent counsel• Companies must provide adequate funding for audit

committees

copyright © 2016 south-western/cengage learning the auditor’s responsibilities regarding fraud...

Documents

southwesterncengage

fraud triangle slide

learning objectives

various types of fraud

rittenberg slide

elements learning objective

dominant fraud scheme

financial results