Question

"Fraud Risk"

• Create a scenario where the external auditors detect that there is fraud. Discuss the auditors’ responsibilities for assessing fraud risk. What are the procedures used to detect material misstatements due to fraud?
• Discuss recommendations to management for reducing fraud.  

Answer 1

A scenario where external auditors detect fraud:

The organization's failure to segregate duties in the finance department.

Opportunity: An employee who process invoices is also given access to the supplier creation system when there is staff shortage. The access is not withdrawn when there is regular staff. The employee spots and opportunity when the financial controller only examines large payments and signs the rest without checking. He creates and makes payments to a non existent supplier.

Concealment: The employee creates fake invoices and submits them for approval. When approved the payments are credited to this bank account and the employee continues this process until discovered.

Discovery: The auditors discover this fraud on examining the supplier list as well as the packaging costs since when goods sold the packaging also must increase proportionately. During audit it is revealed that thousands of dollars have been stolen.

The auditor is responsible for obtaining reasonable assurance that the financial statements are free from mistatements and fraud. He must exercise professional scepticism and recognize the fact that there could be a possibility of fraud irrespective of the client's integrity.

Some of the procedures used to detect material misstatements due to fraud:

1. Comparison of the financial statement figures with the prior period information or the industry average to estimate the average for any expense, liability or asset. Any deviations from expected values must be examined for possibility of fraud.

2. Reading the employment and compensation contracts between the company and its top management to identify any risk of material misstatement

3. Understanding reasons behind selecting any complex accounting principles .

4. Any unusual high and complex transactions eg sales with multiple elements.

Recommendations to management for reducing fraud:

1. Having strong internal controls and reviewing them periodically to ensure they are relevant.

2. There must be low pressure on employees to perform or achieve targets to reduce fraud possibilities.

3. Having thorough background checks of employees.