Question

Discuss factors that an external auditor should consider in assessing the risk of fraudulent financial reporting committed by a public company CFO or CEO. In discussing this topic, please consider risks of fraudulent financial reporting that are related to the fraud triangle (i.e., incentive/pressure, opportunity, and rationalization.). Also, research factors that the PCAOB and the AICPA identify as fraudulent financial reporting risks.

Answer 1

The factors that an external auditor should consider in assessing the risk of fraudulent financial reporting are those that may have been the reasons behind the fraud. The difference between error and fraud is that former is unintentional. Hence fraud always has some intentions or factors that cause it to happen. The fraud can arise from fraudulant financial reporting or misappropriation of assests. Be it on the management level or the lower employees, they tend to make fraud due to a reason or for a purpose. The auditor has to consider those reasons and factors behind the fraudulant act.

The factors that cause the fraud to occur can be of three basic types which come under the fraud triangle. Firstly an incentive or pressure is on the person practising the fraud. This means that many times an incentive comes with certain targets to achive by the employees. Just with the motive of recieving that incentive the employee tends to show false figures of target being achieved. These false figures reflect in the statement making the financial report fraudulant. Pressure is when the managment or employees have a pressure from top officials or stakeholders to complete a task they tend to act in fraudulant ways. Second factor why fraud occurs is when there is absence of controls or controls are ineffective or the ability of management to override controls. In such cases the employees get an opportunity to practice fraud without being inspected or corrected. As before an external auditor the statements are audited internally, hence lack of control or effective management will result in failure of internal audit and occurance of fraud easily. Thirdly such acts are rationalized as being a normal justified act in the personal code of ethics of the employee. It is the attitude and morales of the employee that does not consider the act as a fraud and allows them to perform it intentionally without considering it a fraudulant act.