The Fraud Risk Model and Auditing
Comment on the 10 major steps in the fraud risk model
1. Understand the nature of fraud by identifying the factors associated with fraud that are outlined in the fraud triangle. The factors include rationalization, opportunity, and incentive (ROI).
Incentive/pressure to commit fraud
Fraudulent financial reporting
Management compensation schemes
Financial pressures to improve company’s earnings and balance sheet
Personal wealth tied to either financial results or survival of company
Defalcation (misappropriation of asset)
Personal factors, severe financial considerations
Addictions to gambling/drugs
Opportunities to commit fraud
Due to the complexities of the transactions
Due to lack of control in place. For example, segregation of duties
Rationalizing the fraud (mindset of fraudster to justify committing the fraud)
For fraudulent financial reporting, the rationalization may involve personal or organizational loss (e.g. necessary for the organization to survive, personal compensation based on financial results)
For defalcation, rationalization often resolve around personal issue (e.g. personal financial problem, mistreatment by the company, sense of entitlement that the company owes me)
2. Exercising professional skepticism throughout the audit by exercising a questioning mind on every information and evidence that would suggest a material misstatement due to fraud
3. Conduct brainstorming session
This session is designed to :
Allow experienced auditors to educate less experienced auditors
Discuss whether audit team needs specialist
Set proper level of professional skepticism for the audit
Topics covered during this session include
Consider how fraud can be perpetrated and concealed
Consider ROI for fraud
Consider industry conditions
Consider operating characteristic and financial stability
4. Obtain additional information about fraud risk
a. through specific procedures such as :
Inquiry the management and others (e.g. audit
1. Understand the nature of fraud by identifying the factors associated with fraud that are outlined in the fraud triangle. The factors include rationalization, opportunity, and incentive (ROI).
Incentive/pressure to commit fraud
Fraudulent financial reporting
Management compensation schemes
Financial pressures to improve company’s earnings and balance sheet
Personal wealth tied to either financial results or survival of company
Defalcation (misappropriation of asset)
Personal factors, severe financial considerations
Addictions to gambling/drugs
Opportunities to commit fraud
Due to the complexities of the transactions
Due to lack of control in place. For example, segregation of duties
Rationalizing the fraud (mindset of fraudster to justify committing the fraud)
For fraudulent financial reporting, the rationalization may involve personal or organizational loss (e.g. necessary for the organization to survive, personal compensation based on financial results)
For defalcation, rationalization often resolve around personal issue (e.g. personal financial problem, mistreatment by the company, sense of entitlement that the company owes me)
2. Exercising professional skepticism throughout the audit by exercising a questioning mind on every information and evidence that would suggest a material misstatement due to fraud
3. Conduct brainstorming session
This session is designed to :
Allow experienced auditors to educate less experienced auditors
Discuss whether audit team needs specialist
Set proper level of professional skepticism for the audit
Topics covered during this session include
Consider how fraud can be perpetrated and concealed
Consider ROI for fraud
Consider industry conditions
Consider operating characteristic and financial stability
4. Obtain additional information about fraud risk
a. through specific procedures such as :
Inquiry the management and others (e.g. audit