In this paper we will be discussing fraud
risk in audit procedure, how auditors identify and assess fraud and fraud risk.
In the engagements auditors are not required
to seek for fraud their main responsibility is to look for material
misstatements and mistakes in the financial statements. But due to so many
fraudulent activities within the companies it is now the auditor’s responsibility
to detect material misstatements in the company’s financial statements due to
fraud or error. First of all let’s look at what fraud is. The American Institute of Certified Public Accountants
defines fraud as the intentional
false representation of material fact or its concealment with the aim of making
another party act on this information at his or her own peril. Fraud auditing is
the responsibility of professionals known as auditors. Companies can seek the
services of these individuals through having them as part of the staff
internally at your organization or have external auditors that work on a contractual basis. At other times,
the work done by internal auditors needs to be evaluated by an independent
auditor in order to verify the work done internally. It is not every time that
auditing is done to determine the existence of fraud in the records of an
individual or organization. At times it is done as a common practice to ensure
that financial records are being kept in the right manner and internal controls
are working (Gartland, 2016). There are
two types of misstatements that auditors look for and consider to be a fraud,
misstatements that arise from fraudulent financial reporting and misstatements
that arise from misappropriation of assets.
Misstatements that arise from fraudulent financial reporting are called
intentional misstatements where the information reported on the financial
statements is intentionally altered and doesn’t conform with GAAP principles.
It can be done by manipulating and altering accounting records, supporting
documents, intentional error from the financial statements, transactions or
other information, or intentional misapplication of accounting principles
relating to accounts and amounts on financial statements. Fraudulent financial reporting need not be the
result of a grand plan or conspiracy. It may be that management representatives
rationalize the appropriateness of a material misstatement, for example, as an
aggressive rather than indefensible interpretation of complex accounting rules,
or as a temporary misstatement of financial statements, including interim
statements, expected to be corrected later when operational results improve (Gartland, 2016).
Misstatements that arise from
misappropriation of assets, or theft involve the theft of an entity’s assets
where the effect of the theft causes the financial statements not to be
presented, in all material respects, in conformity with GAAP (Tysiac, 2012).
Misappropriation for assets can be done in many ways, embezzling receipts,
stealing from company’s accounts, assets, or causing the company to pay for
invoices and bills but never actually pay, cause vendors to pay for goods and
services that have never been received. The employee of Ajax Company did
exactly that. He was embezzling from the company by misappropriating the
company’s assets and stealing from the company.
When fraud occurs there are usually three
facts that are present. First of all there is mainly an incentive for the
management or an employee to conduct a fraud or a pressure and that’s the cause
to commit fraud. Second, there are circumstances to commit fraud, some
companies don’t have internal controls, or have unproductive controls, or
management is able to override or trick the internal controls. Third, people
committing fraud usually rationalize their actions as to non harmful. They
don’t have ethical values, aren’t honest and have attitude that allows them to
commit fraud. But, even then honest individuals can commit fraud in an
environment that levies sufficient pressure on them. The greater the incentive
or pressure, the more likely an individual will be able to rationalize the acceptability
of committing fraud. Management has a unique ability to perpetrate fraud
because it frequently is in a position to directly or indirectly manipulate
accounting records and present fraudulent financial information. Fraudulent
financial reporting often involves management override of controls that
otherwise may appear to be operating effectively. Management can either direct
employees to perpetrate fraud or solicit their help in carrying it out. In
addition, management personnel at a component of the entity may be in a
position to manipulate the accounting records of the component in a manner that
causes a material misstatement in the consolidated financial statements of the
entity. Management override of controls can occur in unpredictable ways (DiNapoli,
2016). Those who commit have a good way of hiding it also. They conceal it by
withholding evidence, documents, when documents are requested they usually
falsify them and misrepresent the information. Management for examples can
falsify shipping details, invoices, checks, electronic disbursements and
forging signatures. Fraud also may be concealed through collusion among
management, employees, or third parties. Collusion may cause the auditor who
has properly performed the audit to conclude that evidence provided is
persuasive when it is, in fact, false. For example, through collusion, false
evidence that controls have been operating effectively may be presented to the
auditor, or consistent misleading explanations may be given to the auditor by
more than one individual within the entity to explain an unexpected result of
an analytical procedure. As another example, the auditor may receive a false
confirmation from a third party that is in collusion with management (Tysiac,
It doesn’t matter how well the fraud is
hidden there are certain aspects that trigger suspicion to the auditor. For
example, an auditor may ask for a contract or shipping documents and receive a
response that the paperwork is missing, a ledger might not be correctly
reconciled to its control account, many excuses and misstating information.
This is when an auditor exercises his or her professional skepticism. Because
fraud can be so hard to detect professional skepticism is very important when
considering the rick of material misstatement due to fraud. Professional
skepticism is an attitude that includes a questioning mind and a critical
assessment of audit evidence. The auditor should conduct the engagement with a
mindset that recognizes the possibility that a material misstatement due to
fraud could be present, regardless of any past experience with the entity and
regardless of the auditor’s belief about management’s honesty and integrity.
Furthermore, professional skepticism requires an ongoing questioning of whether
the information and evidence obtained suggests that a material misstatement due
to fraud has occurred. In exercising professional skepticism in gathering and
evaluating evidence, the auditor should not be satisfied with
less-than-persuasive evidence because of a belief that management is honest (DiNapoli,
2016). It takes a lot of work with skepticism on mind. It is challenging
investigating, auditing and detecting employee fraud because there are so many
types of fraud. Most popular fraud topes are
The employee of Ajax Company as discussed above
was involved in asset misappropriation. He simply stoles company’s assets by
checks – he forged signature on the checks and made out to himself.
reimbursement fraud – he forged receipts, double claimed expenses, submitted
false reimbursements claims and inflated expense claims.
fraud – he included vendor fraud schemes n created false customer accounts to
generate false payments, he self-authorized payments and colluded with others
to process false claims for payments.
are many steps to take to prevent and detect asset misappropriation.
detailed background checks on all employees.
checks and balances.
the functions of the one who rights the checks and the one who signs the
duties of employees in accounts.
random audits of company accounts.
pay commission until all the goods and services have been delivered.
checks in locked drawers and destroy voided checks.
detailed internal controls.
management could have prevented the fraud or caught it earlier by
tight internal controls on accounting functions.
the functions of account setup and approval.
random audits of account payable and accounts receivables records.
trusted, unbiased auditor to review and reconciles accounts at regular basis.
duties of employees in accounts payable and accounts receivable.
sure all employees take their vacation times.
an automated system to detect fraud.
balance sheet and payroll accounts each quarter.
The best way to detect employee fraud is through tips,
which is why implementing a whistle blower hotline can be the best deterrent.
According to the ACFE 2016 Report to the Nations, the most common detection
method is tips, with 39.1 per cent of frauds being detected this way. Employees
who know that there’s a hotline and a company culture that encourages its use
have more than just the bosses to be worried about. Every employee becomes the
eyes and ears of the company (Lam, 2014).