Management fraud (e. g., fraudulent financial reporting) is a relatively rare event. However, when it does occur, the frauds (e. g., Enron and WorldCom) can have a significant effect on shareholders, employees, and other parties. AU 240, Consideration of Fraud in a Financial Statement Audit, provides the relevant guidance for auditors.

Required:
a. What is the auditor's responsibility for detecting fraud?
b. Describe the three conditions that are generally present when fraud occurs?
c. What are the objectives of the " brainstorming" meeting that is held among the engagement team members?
d. What is the required documentation for identified risk factors?

A. ANSWER:

The Auditors major responsibility for detecting fraud is to flag it and report it.

EXPLANATION:

He or she may:

Report it to the audit committee or

to the highest level of management (if they are not involved in the fraud), or

to the shareholders if the fraud was and or is being committed by those in senior management

It is also the Auditors responsibility to:

Detect any error leading to a material misstatement. A material misstatement is information in the financial statements that is sufficiently incorrect that it may impact the economic decisions of someone relying on those statements

If the error is immaterial, it should be reported to those charged with governance.

        Here there is no responsibility to detect them.

At the Planning Stage consider in advance, the risk of material misstatement due to fraud and error  

B. ANSWER

The three conditions generally present when fraud occurs are:

Opportunity

Incentive

Rationalization

EXPLANATION

1. Opportunity:

Opportunity refers to circumstances that allow fraud to occur. In the fraud triangle, it is the only component that a company exercises complete control over. Examples of conditions that provide opportunities for committing fraud include but are not limited to: Weak internal controls, lack of integrity at management level, inadequate accounting policies.

2. Incentive:

This is alternatively called pressure, or motive. It refers to an employee’s mindset towards committing fraud. Examples of things that provide incentives for committing fraud include:

Common financial metrics used to assess the performance of an employee are revenues and net income. Bonuses that are based on a financial metric creates pressure for employees to meet targets which, in turn, may cause them to commit fraud to achieve the objective.

The need to meet or exceed investor and analyst expectations can create pressure to commit fraud.

Personal needs may include wanting to earn more money, the need to pay personal bills, a gambling addiction, etc.

3. Rationalization

Rationalization refers to an individual’s justification for committing fraud. Examples of common rationalizations that fraud committers use include:

An individual may be spiteful towards their manager or employer and believe that committing fraud is a way of getting payback.

Lack of integrity at the top may cause an individual to follow in the footsteps of those higher in the corporate hierarchy.

An individual may believe that they might lose everything (for example, losing a job) unless he or she commits fraud.

C. ANSWER

The objectives of the "Fraud Brainstorming" meeting that is held among the engagement team members are to:  

EXPLANATION

D. ANSWER

The required documents for identified risk factors are:

cognitive overload: having a lot on your mind impairs decision-making and tends to result in the simplest, but not necessarily best, option being selected.

empathy gaps: overlooking how you might feel in a different situation can result in unnecessary purchases, such as overbuying when shopping for food on an empty stomach.

optimism and overconfidence: wearing rose-tinted glasses and having unrealistic expectations about the future can affect money management and leave you unprepared for a change in circumstance.

instant gratification: seeking instant gratification drives impulsive spending and can undermine long-term planning and savings.

harmful habits: automatic or mindless behaviour can amplify a poor financial decision as it becomes a recurring event.

social norms: we are heavily influenced by the actions of others; while this can be in certain circumstances, it also contributes to the pressure to keep up with the joneses through conspicuous consumption.