Auditing

th
For the 4 year
CH 11
BY: Ahmed Ebaid
01111073923

MR: Ahmed Ebaid 1 01111073923

 & Planning an Audit and Designing an Audit Approach &

Accept client and perform initial audit planning.

Understand the client’s business and industry.

CH 8
Assess client business risk.

Perform preliminary analytical procedures.

Set materiality and assess acceptable audit risk

CH 9 and inherent risk.

CH 10 Understand internal control and assess control risk.

CH 11 Gather information to assess fraud risks.

CH 13 Develop overall audit plan and audit program.

MR: Ahmed Ebaid 2 01111073923

 & Fraud Auditing &
 Statement on auditing standard no .99:

 Consideration of fraud is a financial statement issued by auditing standard board of

American institute of Certified Public Accountant (AICPA) October 2002.

 Egyptian Auditing Standard (EAS), no 240 issued in august 2008:

 Involve auditor responsibility about fraudulent financial Statements.

 Fraud: Is intentional misstatement of the financial statements.

 Error: Is Unintentional misstatement of the financial statements.

 Factors that increase the fraud:

1. Increase in size of business transaction.

2. Weakness of internal control system.
3. Separation between management and ownership. (conflict in interest)
4. Absence of religious commitment.

& Types of Fraud &

Defalcations Fraudulent Financial Reporting

Corruption Misappropriation of assets

1)Defalcation: "‫”اختالس‬

 Is a type of fraud where employee makes some action for personal gains. Like theft
of assets  cash, inventory or manipulation of money transfer.

 Types of defalcation:

MR: Ahmed Ebaid 3 01111073923

A. Corruption: " ‫”رشوة & فساد‬

 Occurs when fraudsters wrong fully use their influence in a business transaction in
order to gain some benefits for themselves or for other person "conflict of interest".
 For Ex: accepting kickbacks and bribery.
B. Misappropriation of Assets (Employee Fraud):

 Is a fraud that involves theft of an entity's asset. In many cases, but not all, the
amounts involved are not material to the financial statements. However the theft is
management concern, regardless of the materiality of amounts involved, because
small theft can increase over time.

 The term of misappropriation of assets is normally used to refer to the theft

involving employees and others internal to the organization.

 Misappropriation of assets is normally perpetrated at lower level of the organization

hierarchy. In some cases top management is involved in the theft of company asset.

 Ex: theft of inventory or cash.

2)Fraudulent Financial Reporting (Management fraud):

 Is an intentional misstatement or omission of amounts or disclosures with the intent

to deceive users. Most cases involve the intentional misstatement of amounts,
rather than the disclosures.

 Ex: overstatement of assets or omission of liabilities.

 Most cases of fraudulent financial reporting involve an attempt to overstate income,

either by overstate asset or income or by omission of liabilities and expenses,
companies also deliberately understate income. At private company it may be done to
reduce income tax, or when earnings are high to create a reserve earnings "cookie jar
reserve" that may be used to increase income in the future periods. Such practice called
Income Smoothing & Earnings Management.

 Earnings management: involves a deliberate action taken by

management to meet earning objective.

 Income smoothing: Is a form of earnings management in which

revenue and expenses are shifted between periods to reduce fluctuation in
earnings.

MR: Ahmed Ebaid 4 01111073923

 & Describe fraud triangle and condition for fraud &

&Fraud triangle&

Incentives/Pressures

Opportunities Attitudes/Rationalization

& Conditions for Fraud &

 Three conditions for fraud arising from fraudulent financial reporting and
misappropriation of assets are described in SAS 99 (AU316) as the following …….

1) Incentive/ pressures:

 Management or other employees have incentives or pressure to commit fraud.

2) Opportunities:

 Circumstances provide opportunities for management or employees to commit

fraud.

3) Attitude/Rationalization:

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  An attitude, character, or set of ethical values exists that allows management or
employees to commit a dishonest act, or they are in environments that impose
sufficient pressure that causes them to commit a dishonest act.

 Risk factors for fraudulent financial reporting Examples:

1) Incentive / Pressure

 Financial stability or profitability is threatened by economic, industry, or entity

operating conditions.
 Excessive pressure exists for management to meet debt requirements.

 Manager or board of directors Personal net worth is materially threatened

2) Opportunities

 In effective audit committee or board of directors oversight over financial reporting.

 High turnover or ineffective accounting, internal audit, or information technology staff exists.

3) Attitude/Rationalizatio
n

 Inappropriate or inefficient communication and support of the entity’s values.

 A history of violations of laws is known.
 Management has a practice of making overly aggressive or unrealistic forecasts.

 Risk factor for misappropriation of assets Examples:

1) Incentive / Pressure

 Personal financial obligations create pressure to misappropriate assets.

 Adverse relationships between management and employees motivate employees to
misappropriate assets.

2) Opportunities

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 There is a presence of large amounts of cash on hand or inventory items with high value.
 There is an inadequate internal control over assets.

3) Attitude/Rationalizatio
n
 Disregard for the need to monitor or reduce risk of misappropriating assets exists.
 There is a disregard for internal controls to correct internal control deficiencies.

& Assessing fraud risk &

 Auditor must maintain level of professional skepticism as they consider a board set
of information including fraud risk factor to identify and respond to fraud risk.

 Professional skepticism: SAS 1 states that "auditor neither assumes that

management is dishonest nor assumes unquestioned honesty", it includes questioning
mind and critical evaluation of evidence.

(A) Questioning mind: -

 SAS99 emphasize consideration of client's susceptibility to fraud, regardless of the
auditors believes about the likelihood of fraud and management honesty and integrity.

(B) Critical evaluation of audit evidence: -

 Upon discovering information or other conditions that indicate a material
misstatement due to fraud may have occurred, auditor should thoroughly probe the
issue, acquire additional evidence as needed, and consult with other team member.

Note:
 The existence of fraud risk factors doesn't mean fraud exist, only likelihood of fraud is
higher.
 The auditor should perform analytical procedure on revenue account as the
occurrences of fraudulent financial reporting often involve manipulation of revenue.

& Source of information to assess fraud risks &

MR: Ahmed Ebaid 7 01111073923

 Communication Inquiries of Risk Analytical Other
among audit team management factors procedures information

Identified risks of material misstatements due to fraud

1) Communication among audit team: SAS99 require the audit team to

conduct dissection since it helps in……..

 How management could perpetrate and conceal fraudulent FR.

 How anyone may appropriate the asset of the entity.
 How the auditor might respond to the susceptibility of material misstatement due to
fraud.

2) Inquires of management:

 SAS99 requires auditor to make specific inquires about fraud in every audit. Since
inquires enable auditor to know information that’s not communicated.

3) Risk factor:

 SAS 99 requires the auditor to evaluate whether fraud risk factors indicate incentive,
opportunities, attitudes used to justify fraud action.

4) Analytical procedures:

 Auditor should perform analytical procedures at the planning and completion phases of
audit to help identify unusual events that might indicate the presence of material
misstatement.

5) Other information:

 Auditor should consider all information obtained in any audit phases to assess fraud risk.

& Documenting fraud assessment &

MR: Ahmed Ebaid 8 01111073923

  Auditing standard requires that auditors document the following matters related to
auditor consideration of material misstatement due to fraud:
 Discussion: "between engagement team"
 Procedures: "performed by auditor to detect fraud"
 Reasons: "fraud exist or not"
 Results: "of procedure performed”
 Nature of communications: " made to management and audit committee and
other about fraud"
 Specific risks of material fraud
 Other conditions: " if the procedures not enough"
& Corporate governance oversight to reduce fraud risk &

 Management is responsible for implementing corporate governance and control

procedures to minimize fraud risk.

 Guidance that helps in prevent, detect fraud ass the follow…..

1- Culture of honesty and high ethics.
2- Management's responsibility to evaluate risk of fraud.
3- Audit committee oversight.

1)Culture of honesty and high ethics:

 Setting the tone at the top.

 Create positive workplace environment.
 Hiring and promoting efficient employees.
 Confirmation on code of ethics.
 Discipline

2)Management responsibility to evaluate fraud:

 Identify and measuring fraud risks.

 Mitigating fraud risks.
 Monitoring fraud prevention programs and control.

3)Audit committee oversight:

 Overseeing organization financial reporting and internal control process.

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  Assisting in creating an effective "tone at the top” and importance of honesty and
ethical behavior.
 Overseeing actions of management.

 Notes: Management responsibility to evaluate risk of fraud:

 According to the new researches there are many organizational factors contributed to
risk of fraud:

1. Collusion between employees and third parties. (80%)

2. Management override of internal control.
3. Inadequate internal control.
4. Collusion between employees and management.
5. Lack of control over management by directors.

& Responding to risk of fraud &

 Auditor respond to fraud risk include the following:

1. Change the over all conduct of audit.
2. Design and perform audit procedures to address fraud risks.
3. Design and perform procedures to address management override of controls.

 Auditor must perform 3 procedures in every audit to address risk of management

override:

1.Examine journal entries and other adjustments for evidence of possible

misstatement due to fraud.
2.Review accounting estimates for bases.
3.Evaluate business rational for significant unusual transaction.

 Specific fraud risk areas:

 Revenue and account receivable fraud risk.

 Inventory fraud risk.
 Purchase and account payable fraud risk.
 Other areas of fraud risk.

MR: Ahmed Ebaid 10 01111073923