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 the auditor’s responsibility
to detect material misstatements in the company’s financial statements brought
on by 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 (Gartland, 2016).
It is the responsibility of publicly certified accountants to perform auditing
procedures to eliminate fraudulent activities. Companies usually hire auditors
and pay for their services on a contractual basis. If companies have internal
auditors then they have to hire independent auditors in order to evaluate their
internal work. Auditing services are conducted not only to find fraud or detect
fraudulent activities but also to make sure that companies financial records
are being recorded correctly and internal accounting systems are working
There are two common categories
of fraud, misstatements brought on by fraudulent financial reporting and
misstatements brought on by misappropriation of assets.
Misstatements brought on by fraudulent
financial reporting are called intentional misstatements. In this case 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, purposely altering
information on the financial statements , transactions or other information,
and purposely misuse of accounting
principles related to accounts and amounts on financial statements. Fraudulent or intentional financial reporting
can be caused by many reasons. It can be intentional fraud, or employees mainly
executive and management team justifying the misstatement as necessary to save
the company and employees with the intention to correct and the misstatement
when financial situation improves (Gartland,
Misstatements brought on by
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, for example one can cheat numbers on receipts, steal from
company’s accounts, assets, or release money from companies accounts towards
invoices and bills but never actually pay, receive money paid by vendors to
one’s own account etc. 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. Sometimes people who are honest and good people by nature are
capable of committing fraud. If they are in an environment that puts lots of
pressure on them, or they are afraid of losing their job, or an unfortunate
accident happens in one’s life they can cross the line by rationalizing their
actions and accepting their wrongdoing. 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 (DiNapoli,
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 can be hidden in many
ways. It can be hidden through conspiracy executive team, management and
employees who work in accounting department, or clients and vendors, even
independent accounting firms. Conspiracy is very dangerous. It can make very
difficult to detect fraud, even the auditor who followed all proper procedures
can be fooled. For example, through conspiracy,
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 who is in fact in an agreement with
management (Tysiac, 2012).
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 a key point in
consideration of material misstatement brought on by fraud. Professional
skepticism is a mindset that questions everything, sees untruthfulness in
everything and everywhere and organized and detail oriented attitude that
inspects every speck of audit evidence. The audit is conducted with a notion
that there is a material misstatement in the financial statements, doesn’t
matter how well the auditor knows the company, how many he or she worked with
the company, the mindset needs to be questioning everything at all times. 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
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.
There are many steps to take in order to become alerted and distinguish
thorough background checks on all employees.
sure checks and balances in place. Meaning same person is not issuing and
have different employees performing the accounting functions of the one who
rights the checks and the one who signs the checks.
job responsibilities of employees in accounting department.
unexpected audits of company accounts.
pay commissions until all the goods and services have been delivered.
all the checks in safe and well preserved cabinets and shred voided checks.
place detailed internal controls.
The management of AJAX Company could have prevented the fraud or caught
it earlier by
in place detailed internal controls on accounting roles.
the responsibilities of account setup and approval.
unexpected audits of account payable and accounts receivables records.
trusted, unbiased auditor to review and reconciles accounts at regular basis.
responsibilities of employees in accounts payable and accounts receivable.
sure all employees take their vacation times.
up reliable, internal 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 (Lam, 2014).