While audits are not designed to root out every instance of fraud, auditors have a responsibility to detect material misstatements in the company's financial statements caused by either fraud or error. Accordingly, generally accepted auditing principles prescribe specific audit procedures to detect fraud that must be carried out during each audit. Knowing some of these procedures can help you better align resources for your company's audit.
Fraud Brainstorming Session
Under generally accepted auditing standards, audit engagement teams must hold a fraud brainstorming session at the beginning of the audit. This session, led by the partner in charge of the audit, is designed to provide a time for the audit team to consider how the company could commit fraud. Further, the brainstorming meeting is used to set a tone of professional skepticism in the audit. Often, a fraud specialist attends the meeting to provide insight into other frauds committed by similar companies or industries and help identify the client's risk factors.
Journal Entry Testing
Because committing material financial statement fraud often requires adjustments to the company's financial records, auditors will test the company's journal entries for any signs of manipulation. To perform this test, after gaining an understanding of the company's controls and procedures, the auditor will make a selection from the company's journal entries. Auditors typically select entries that are large, made by upper management, posted late in the accounting period or otherwise of interest. Once the selections have been made, the auditor will ask for supporting documentation that validates each entry.
Another likely place for fraud is in accounting estimates. Because accounting estimates are subjective, management may be able to influence accounting estimates to manipulate the financial statements. Auditors look for fraud in accounting estimates in two major manners. First, auditors complete a "lookback" procedure to determine if the methodology for completing accounting estimates has changed from the prior year. Changes in methodology could be a sign of manipulation. Auditors also examine the directionality of estimates as a whole. For example, if nearly all estimates in the prior year were of decreasing income and nearly all estimates in the current year were of increasing income, auditors may be concerned that the company is shifting income from one period to another.
Significant Unusual Transactions
Recent revisions in generally accepted auditing principles require that auditors closely examine significant unusual transactions outside of a company's normal business operations. This examination requires companies to explain the purpose and business rationale for the transaction. Once the auditor obtains management's explanation, the engagement team should corroborate management's response with other information received during the audit.
AUDIT PROCEDURES TO DETECT FRAUD
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Copyright © Daniel Cullinane CPA.
Daniel Cullinane CPA
25 Plaza 5 25th fl Jersey City NJ phone 732-516-1648 fax 732-516-9778