Date post: | 22-Dec-2015 |
Category: |
Documents |
Upload: | willis-rogers |
View: | 213 times |
Download: | 0 times |
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
Copyright © 2016 South-Western/Cengage Learning 2-3
THE AUDIT OPINION FORMULATION PROCESS
Copyright © 2016 South-Western/Cengage Learning
DEFINE THE VARIOUS TYPES OF FRAUD THAT AFFECT ORGANIZATIONS
LEARNING OBJECTIVE 1
Copyright © 2016 South-Western/Cengage Learning 2-5
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
Copyright © 2016 South-Western/Cengage Learning 2-6
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
Copyright © 2016 South-Western/Cengage Learning 2-7
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
Copyright © 2016 South-Western/Cengage Learning
DEFINE THE FRAUD TRIANGLE AND DESCRIBE ITS THREE ELEMENTS
LEARNING OBJECTIVE 2
Copyright © 2016 South-Western/Cengage Learning 2-9
EXHIBIT 2.2 - THE FRAUD TRIANGLE
Copyright © 2016 South-Western/Cengage Learning 2-10
INCENTIVES TO COMMIT FRAUD
Copyright © 2016 South-Western/Cengage Learning 2-11
OPPORTUNITIES TO COMMIT FRAUD
Copyright © 2016 South-Western/Cengage Learning 2-12
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
Copyright © 2016 South-Western/Cengage Learning
DESCRIBE IMPLICATIONS FOR AUDITORS OF RECENT FRAUDULENT FINANCIAL REPORTING
CASES AND THE THIRD COSO REPORT ON FRAUD
LEARNING OBJECTIVE 3
Copyright © 2016 South-Western/Cengage Learning 2-14
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
Copyright © 2016 South-Western/Cengage Learning 2-15
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
Copyright © 2016 South-Western/Cengage Learning
DISCUSS AUDITORS’ FRAUD-RELATED RESPONSIBILITIES
AND USERS’ RELATED EXPECTATIONS
LEARNING OBJECTIVE 4
Copyright © 2016 South-Western/Cengage Learning 2-17
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
Copyright © 2016 South-Western/Cengage Learning 2-18
MESSAGE TO AUDITORS
• Assume greater responsibility for detecting fraud• Provide assurance that financial statements are free
of material fraud
Copyright © 2016 South-Western/Cengage Learning
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
LEARNING OBJECTIVE 5
Copyright © 2016 South-Western/Cengage Learning 2-20
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
Copyright © 2016 South-Western/Cengage Learning
DEFINE CORPORATE GOVERNANCE, IDENTIFY THE PARTIES INVOLVED, AND DESCRIBE THEIR
RESPECTIVE ACTIVITIES
LEARNING OBJECTIVE 6
Copyright © 2016 South-Western/Cengage Learning 2-22
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
Copyright © 2016 South-Western/Cengage Learning 2-23
EXHIBIT 2.5 - OVERVIEW OF CORPORATE GOVERNANCE RESPONSIBILITIES AND ACCOUNTABILITIES
Copyright © 2016 South-Western/Cengage Learning 2-24
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
Copyright © 2016 South-Western/Cengage Learning 2-25
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
Copyright © 2016 South-Western/Cengage Learning 2-26
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