What is Fraud?
Fraud occurs when individuals purposely materially misstate facts with the intent of coercing someone to believe these misrepresentations. Upon believing the misrepresentation, individuals will act upon them and suffer a loss or damages.
Fraud occurs in various forms:
1. Misappropriation of assets
2. Fraudulent financial reporting
3. Employee fraud
4. Management fraud
The Fraud Triangle
* Motive/Incentive: a reason to commit the fraud
* Opportunity: the chance for an individual to violate a trust. * Attitudes/Rationalizations: an individual has a lapse in ethical and moral values. When combined with motive and an opportunity, fraud occurs
Corporate Governance and Reducing Fraud Risks
* Management and the board of directors are responsible for implementing control procedures and corporate governance to minimize or prevent fraud. * Therefore, programs implemented by management include:
Creating a Culture of Honesty and High Ethics:
* Embraces its core values.
* Tone with management
* Positive workplace environment
* Hire and promote appropriate employees
* Train all new employees on ethical conduct
* Reconfirm that employees understand their responsibilities * Discipline
Responsibility to Manage Risks of Fraud:
* An effective fraud risk management process should include the following principles: 1. Written policy clarifying board of directors/management’s expectations regarding fraud risk 2. Fraud risk exposures should be assessed
3. Establish controls and actions to prevent or mitigate fraud risks 4. If prevention or mitigation fails, controls and actions to detect fraud are present 5. Communication, reporting and monitoring used to update the fraud management process organization-wide and on a timely basis. * Senior managers and the board of directors are responsible for oversight; management must identify, measure and reduce existing fraud risks. * Management should regularly evaluate the effectiveness of antifraud programs and controls. Audit Committee Oversight:
* Responsibility to oversee financial reporting and internal control processes. * Must be aware of the potential for management to override internal controls * The audit committee itself is a deterrent to fraud
The Auditor’s Role in Assessing Fraud Risks
* The most important thing an auditor can maintain is professional skepticism. * All members of the audit team must discuss their opinions and insights regarding the likelihood of a client to fraud or error. * In every audit, the auditor must inquire about fraud risks.
The Auditor and Responding to the Risk of Fraud
* When material misstatements are identified, findings are discussed with management. * Auditor’s response to fraud generally includes:
* Change the overall conduct of the audit
* Design and perform procedures to address risks that have been identified * Design and perform procedures to address the risk of management controls override * There are a variety of ways to respond to an increased risk of fraud - more experienced individuals, fraud expert, etc. * Auditors should be conscious of management’s accounting policy selection * Unpredictability should be incorporated into audit plans.
* Although fraud is often very difficult to detect, there are generally some red flags * Employee fraud:
* Any changes in lifestyle and habits
* Specific characteristics
* Telltale hints of cover up in the accounting records * Fraudulent financial reporting:
* Specific circumstances within the company
Why Do Auditors Fail to Detect Fraud?
* Over reliance on client representations
* Failure to maintain an appropriate level of professional skepticism * Failure to recognize signs that may indicate a material fraud * Lack of...
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