Question

Regarding SAS 99 and the fraud triangle, how does the auditor formulate fraud risk? Is the auditor responsible for detecting earnings management?

Answer 1

SAS 99 describes a process under which the auditor collects all the information required to inspect risks of material misstatement due to fraud, assesses these risks after considering evaluation of the entity’s programs and controls and responds to the results. Under SAS no. 99, auditor will collect and consider more information to assess fraud risks than collected and assessed earlier or in the past. This suggests auditors that they should consider key points like possessing unbiased nature, questioning mind and setting aside past relationships particularly during audit planning and the evaluation of audit evidence. Fraud Triangle describes three main points which are:

1.Pressure/incentive to perpetrate fraud

2.Opportunity to carry out the fraud

3.Attitude to justify fraudulent action.

An auditor uses SAS 99 and fraud triangle in formulating fraud risk. According to SAS 99, auditor  gathers all required information, assess it and responds to result. He will detect fraud and tries to find out due to which component of fraud triangle fraud risk took place. Whether the risk is associated with pressure or the entity or management got the opportunity to do fraud or they possess the character or attitude to justify such fraudulent actions.

Earnings management covers a wide variety of legitimate and illegitimate actions by management that gives impacts on entity’s earnings. It focuses  on the whole spectrum and how the auditor’s role in improving the credibility of financial information is affected by the different ways in which earnings can be managed. We can say that auditor is responsible for detecting earnings management as he is the person who looks at each and every activity very deeply and observes their impact keenly. So, he is the person who can detect it and hide it by ignoring such fraudulent activities. Detection of earning management based upon accounting accruals. If the accruals are abnormal then we can say that earning management has been postulated. The behavior of the auditor demands professional skepticism as "auditor is watched dog, not a bloodhound”.

Detection of earning management can be measured by two approaches:

1. Aggregate accrual method approach

2. Specific accrual method approach