Academic journal article Journal of Accountancy

Auditors' New Procedures for Detecting Fraud; ED's Proposed Changes Address Fraudulent Financial Statements

Academic journal article Journal of Accountancy

Auditors' New Procedures for Detecting Fraud; ED's Proposed Changes Address Fraudulent Financial Statements

Article excerpt

EXECUTIVE SUMMARY

* THE ASB ISSUED AN EXPOSURE DRAFT designed to expand audit procedures to address material financial statement fraud. Comments on the proposed changes are due by May 31, 2002.

* THE ED EMPHASIZES CONSIDERING A CLIENT'S susceptibility to fraud, regardless of the auditor's past experience with the entity or prior beliefs about management's honesty and integrity. And it requires

* AUDIT TEAMS TO DISCUSS during the planning stage the potential for material misstatements due to fraud.

* AUDITORS TO QUERY MANAGEMENT about its views of the risks of fraud in the entity and its knowledge of any known or suspected fraud.

* AUDITORS TO BROADEN THE RANGE of information they use to assess the risks of material misstatement due to fraud, beyond the fraud risk factors provided in SAS no. 82.

* AUDITORS TO CONSIDER MANAGEMENT'S PROGRAMS and controls to address risks and determine whether such programs and controls will mitigate or exacerbate the identified risks.

* AUDITORS TO DEVELOP AN APPROPRIATE RESPONSE for each fraud risk identified. Planned procedures should consider the risk of management override of controls: They include auditors' examining journal entries and other adjustments, reviewing accounting estimates for bias and evaluating the business rationale for significant unusual transactions.

We face a crisis of confidence in our financial reporting system. An increasing number of restatements and fraud allegations, often in conjunction with large business failures, contributes to concerns about the quality of financial statements. Thus, preventing and detecting material financial statement fraud are a focus for investors, regulators, management and auditors.

The AICPA auditing standards board (ASB) took a significant step toward addressing this problem by issuing an exposure draft of a proposed Statement on Auditing Standards, Consideration of Fraud in a Financial Statement Audit, which would supersede SAS no. 82. The ED does not change any of the auditor's current responsibilities for fraud in a financial statement audit. However, it introduces new concepts, requirements and guidance to assist auditors in meeting those responsibilities. In applying the proposed guidance, auditors would plan and perform every audit with a questioning mind, recognizing the possibility that a material misstatement due to fraud could be present, regardless of past experience with the entity or prior beliefs about management's honesty and integrity. Auditors would continue to be responsible for planning and performing the audit to obtain reasonable assurance that financial statements are free of material misstatements due to fraud--whether arising from fraudulent financial reporting or asset misappropriation. This article discusses some of the more significant changes from SAS no. 82 and the potential effects on audits so that practitioners may express their opinions on these proposals to before the end of the ED's comment period on May 31, 2002.

NEW CONTEXT FOR CONSIDERING RISKS

To provide a richer understanding of the environment in which fraud is likely to occur, the ED expands the description of fraud and its characteristics. It describes three conditions generally present when fraud occurs--incentive/pressure, opportunity and attitude/rationalization (see "The Fraud Triangle" page 63). Input from forensic experts, academics and others consistently showed that evaluation of information about fraud was enhanced when auditors considered it in the context of these three conditions.

TEAM DISCUSSION AND PROFESSIONAL SKEPTICISM

To increase awareness and sensitivity to fraud, and to enhance the fraud-risk-assessment process, the ED requires audit team members to discuss during the planning stage the potential for material misstatements due to fraud. The more experienced team members should share their insights, and all the members should exchange ideas about how and where the entity's financial statements might be susceptible to material misstatements due to fraud. …

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