Why do auditors fail to detect frauds

Liotta, director—auditing for Consolidated Edison Co. But SAS no. As Liotta, a member of the American Institute of CPAs auditing standards board fraud task force, pointed out, "This can happen with any technical pronouncement; for example, a companys internal costs can go up in complying with a Financial Accounting Standards Board statement.

Relationship with external auditor. What will companies themselves have to do differently, both internally and in their interactions with their auditors? When he is asked this question, Liotta said he points to two paragraphs in SAS no.

Paragraph 13 requires the public accountant to make an inquiry of management to obtain its understanding about the risk of fraud in the entity and to determine whether it knows of any fraud perpetrated against the entity. When well-run companies with good managements are asked straightforward questions, they like to give straightforward answers.

Changes in the management representation letter are now being developed to incorporate the new fraud terminology. Liotta believes signing this letter will cause management to think carefully about what information the letter includes. Liotta said SAS no. According to Liotta, "Research has shown that more frauds will be found by simply asking the right questions.

Many people in an organization know something is going on but dont have an outlet to talk about it. If the auditor simply sits down with them, he or she can find out quite a bit. Liotta sees paragraph 24 of SAS no. It says that if an entity has established a program designed to deter and detect fraud, the auditor may—but does not have to—consider its effectiveness.

But the auditor should still question the staff overseeing the program to determine whether it has identified any fraud risk factors. Liotta said organizations have established many different programs to deter and detect fraud—internal audit departments, ethics hotlines and security departments.

Because many corporations are organized as corporate holding groups or management companies and most business activities are carried out at a subsidiary level, Liotta said the real assessment of risk has to be done at the subsidiary level. He said paragraph 17 of SAS no.

Internal auditors wont be surprised by the factors, Liotta said, "but they will help them to look at fraudulent financial reporting from a subsidiary viewpoint. The numbers and the effect could be significant. Overall effect. Asked about the likely impact of SAS no.

Auditors have a basis for determining compliance only with laws and regulations that have a direct and material effect on the determination of financial statement amounts, such as tax laws or the determination of revenue earned under a government contract. It isnt feasible to design an audit to provide reasonable assurance of detecting all illegal acts that could have a material effect on financial statements.

These include laws governing securities issuance and trading, occupational safety and health, food and drug administration, environmental protection, price fixing and antitrust violations. As a practical matter, auditors have little chance of detecting most illegal acts unless informed of them by the client or if there is evidence of a government investigation or enforcement proceeding in corporate documents available to the auditor.

The sidebar that appears above identifies some nonauthoritative practice aids on SAS no. Once the SAS has been in use for two busy seasons, the ASB will evaluate how well it has accomplished its objectives and identify any further steps that need to be taken. This feedback process also may help identify specific issues for further research on fraud deterrence and detection. The American Institute of CPAs is rolling out a new effort to provide user-friendly standards by offering implementation guidance on Statement on Auditing Standards no.

These implementation efforts include. For information and to register, call and give the operator code WR. A video CPE self-study course based on these presentations will be available in late summer. Note: The above prices do not include sales tax or shipping and handling. To order, call between a. Making the right moves now can help you mitigate any surprises heading into Worldwide leaders in public and management accounting. Toggle search Toggle navigation.

Breaking News. It provides expanded operational guidance on the auditors consideration of material fraud in conducting a financial statement audit. That responsibility is still framed by the key concepts of materiality and reasonable assurance. The auditors assessment is a cumulative process that is ongoing throughout the audit. If the resulting misstatement is not material to the financial statements, the auditor should refer the matter to an appropriate level of management at least one level above those involved.

Recover your password. Get help. Before we even look for reasons we must understand that neither financial accounting process used to prepare general purpose financial statements or auditing and assurance engagements are of great help to detect fraud.

Fraud is what neither accounts preparing financial statements nor the ones giving opinion on such financial statements are after. So basic lack of instinct to detect fraud makes the very foundation of inabilities to detect fraud. Please enter your comment! Please enter your name here. To help generate creative, practical ideas, pose questions people can more easily understand, such as the following:. If you were the bookkeeper for the entity, how could you embezzle funds and not get caught?

If you worked on the loading dock, how could you steal inventory? If you owned this company, how might you manipulate the financial statements to impress bankers? Here are some examples. No ideas or questions are dumb. There may be a time and a place for battling over the validity of an idea, but a brainstorming session is not one of them.

There is no hierarchy. The world of ideas does not recognize rank, experience or compensation level. Excessive note-taking is not allowed. A brainstorming session is an intuitive, spontaneous process. Excessive note taking is a barrier to this process. It provides guidance on obtaining information from. Management and others within the organization.

Analytical procedures. Consideration of fraud risk factors. Other sources. Several of these inquiries were not required under previous standards. The guidance contained in SAS no. For the most part, auditors tend to restrict their client inquiries to personnel directly involved in the financial-reporting process.

This approach is appropriate for matters of which accounting personnel have direct knowledge—for example, how transactions are processed or controlled. However, it is less effective to ask accounting personnel about matters of which they do not have first-hand knowledge for example, the procedures used to examine, count and receive items into inventory.

SAS no. Operating personnel not directly involved in the financial-reporting process. People with knowledge of complex or unusual transactions. In-house legal counsel. Further, you should not restrict your inquiries to senior management. The standard suggests making inquiries of personnel at various levels within the organization. These are two primary objectives in making such inquiries. To obtain first-hand knowledge of fraud. Fraud can happen in any department and at any level within the organization.

Someone in the entity may have observed a person committing or concealing a fraud. To corroborate or lend perspective to representations of others. The standard allows you to use considerable judgment in determining to which employees within the organization you should direct your inquiries and what questions you should ask.

However, it does not restrict you to making only those inquiries. In fact, it encourages you to make additional inquiries in order to gather or corroborate a wide variety of information that can help you identify or assess risks of material misstatement due to fraud. Many of the queries related to these matters should be submitted to personnel outside of management or the accounting department.

For example, you may wish to use inquiries to. Identify the presence of the fraud triangle characteristics. Understand the policies, procedures and controls for recording journal entries or other adjustments. Identify circumstances under which management has or may override internal controls. Understand policies and procedures related to revenue recognition. Understand the business rationale for significant unusual transactions.

Asking the same question of different people can increase the effectiveness of your inquiries, as you can compare answers to identify consistencies or anomalies in the responses. For that reason, SAS no. Although fraud risk factors do not necessarily indicate that fraud exists, they often are warning signs where it does.

Like SAS no. However, in SAS no. Auditors are cautioned not to think that these fraud risk factors are all-inclusive. In fact, research has found that auditors who used open-ended questions that encouraged them to develop their own fraud risk factors outperformed those who relied on a checklist based on looking only for the illustrated fraud risk factors.

However, during the course of your engagement, you may become aware of circumstances that indicate the possible presence of an attitude or ability to rationalize that you consider to be a fraud risk. For example, a recurring attempt by management to justify marginal, inappropriate accounting on the basis of materiality and a strained relationship between management and the current or predecessor auditor are fraud risks relating to fraudulent financial reporting.

This other data can be gleaned during. Client acceptance and continuance procedures.