An over-reliance on inquiry as the only means of audit evidence.
A lack of awareness that some observed conditions, "RED FLAGS" may indicate a material fraud.
A tendency to look at current numbers in isolation from the past or other relevant information.
Allowing time & budget pressures to influence the audit
A lack of skepticism
Factors and Conditions
There a number of factors and conditions that the auditor needs to be aware of that may present a risk of material misstatement.
Management Characteristics and Influence over the Control Environment
Industry Conditions
Operating Characteristics and Financial Stability
Management Characteristics & Influence Over the Control Environment
A significant portion of management’s compensation represented by bonuses, stock options, or other incentives, the value of which is contingent upon the entity achieving unduly aggressive targets for operating results, financial position or cash flow.
An excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend through the use of unusually aggressive accounting practices.
A failure by management (either executive management, financial management, or the entity’s governing body) to display and communicate an appropriate attitude regarding internal control and the financial reporting process.
An ineffective means of communicating and supporting the entity’s values or ethics, or communication of inappropriate values or ethics.
Industry Conditions
New accounting, statutory, or regulatory requirements that could impair the financial stability or profitability of the entity.
Declining industry with increasing failures and significant declines in customer demands.
Rapid changes in the industry, such as high vulnerability to rapidly changing technology or rapid product obsolescence.
Operating Characteristics and Financial Stability
Significant pressure to obtain additional capital necessary to stay competitive considering the financial position of the entity - including need for funds to finance major research and development or other capital expenditures.
Overly complex organizational structure involving numerous or unusual legal entities, managerial lines of authority, or contractual arrangements without apparent business justification.
Unrealistically aggressive sales or profitability incentives.
Unusually high dependence on debt or marginal ability to meet debt repayment requirements; debt covenants that are difficult to maintain.
Common Fraud Schemes
Cash
Most common way cash is defrauded is through fraudulent disbursements.
Under these schemes, the employee uses the entities checks to either:
withdraw cash directly for his/her benefit or
pay personal expenses
Entities that handle large amounts of cash are susceptible to theft of cash on hand:
Skimming
Substituting personal checks for cash.
Fictitious refunds or discounts
Altered credit card receipts
What to Look For
Missing checks or checks out of sequence
Employee personal checks found in cash drawers
Large, unexplained reconciling items in the bank reconciliations
Unusual endorsements on checks
Bank statements that do not include canceled checks
Some canceled checks are missing
Disbursements unsupported by invoices or other documentation
Customer complaints
Altered or missing cash register tapes
Example Audit Procedures
Examine bank reconciliations
Review bank statements and canceled checks
Obtain a bank cut-off statement
Perform analytical procedures (at high precision levels) on expense reports
Search for and examine unusual expense account activity close to year end
Perform surprise cash accounts
Analyze sales discounts and returns
Review vendor list with management and investigate any payments to unknown or unusual vendors
Compare check endorsements to payee information
Revenue Recognition-Frauds
Recording fictitious sales
Recognizing revenue on transactions that do not meet the revenue recognition criteria
Sham transactions
Recognizing revenues in the improper period
What to Look For
Excessive credit memo and credit adjustments to accounts receivable after the end of the accounting period.
Customer complaints and discrepancies in accounts receivable confirmations.
Unusual entries to the accounts receivable subledger or sales journal
Missing or altered source documents or the inability of the client to produce original documents in a reasonable time.
A lack of cash flow from operating activities has been reported.
Unusual reconciling differences between sales and the general ledger.
Sales to customers in the last month before the end of the accounting period at terms more favorable than previous months.
Sales with affiliates and related parties.
Pre-dated or post-dated transactions.
Journal entries made to the sales or revenue account directly, that is, not posted from the accounts receivable subledger or sales journal.
Large or unusual adjustments to sales accounts made just prior to or just after the end of the period.
Example Audit Procedures
Perform a thorough review of original source documents including shipping documents, customer purchase orders, cash receipts, and written correspondence between the client and customer
Analyze and review credit memos and other accounts receivable adjustments for the period subsequent to the balance sheet date
As part of the accounts receivable confirmation effort, confirm with customers the terms of sales agreements, including the absence of right of return and terms that might preclude immediate revenue recognition.
Analyze all large or unusual sales made in the last month prior to the end of the period. Vouch to original source documents. Confirm terms of the transaction directly with the customer.
Scan the general ledger, accounts receivable subledger and sales journal for unusual activity.
Compare operating cash flow to sales. Analyze by salesperson, location, or product.
Accounts Receivable Frauds
Lapping
Posting improper credits to the account.
Altering internal copies of invoices.
Diversion of payments from written-off accounts.
What to Look For
Unexplained differences noted by customers on their accounts receivable confirmations.
Significant delays between the date the customer states a payment was made and the date payment was recorded as received by the company.
A significant number of credit entries and other adjustments made to the accounts receivable records.
Unexplained or inadequately explained differences between the accounts receivable subsidiary ledger and the general ledger.
Discrepancies between customer names and amounts on deposit slips and subledger accounts and amounts credited.
Example Audit Procedures
Confirm account activity (not just the balance) with the customer.
Perform analytical reviews of credit memo and write off activity.
Vouch credit memos and other writeoffs to receiving records for returned goods, customer correspondence and other documentation supporting the transaction.
Purchasing & Payroll
Most common fraud scheme is the payment of invoices to a fictitious company
Another common fraud is a kickback.
Allowing the vendor to submit fraudulent billing and approving payment
Excess purchasing of property or services
Bid rigging
Most common payroll fraud is the use of ghost employees
Another common fraud is an overpayment scheme
What to Look For - Fictitious Vendors
Photocopied invoices or invoices that have been tampered
Invoice numbers from the same vendor that occur in an unbroken consecutive sequence
Invoice from companies with a P.O. Box address and/or no phone number
Invoices from companies with the same address or phone number as an employee
The amount of each invoice from a particular vendor falls just below a threshold for review
Multiple companies that have the same address and phone number
What to Look For - Kickbacks
Purchasing agent handles all matters related to a vendor even though it might be outside or below his normal duties
Vendors who receive an inordinate amount of business for no apparent business reason
Vendor salesmen make frequent, unexplained visits to purchasing personnel
Prices from a particular vendor are unreasonably high when compared to others
Quality of goods or services received from a vendor is low
Tips or complaints from other employees or honest vendors
Key contracts awarded with no formal bid process
Purchase of excess goods
What to Look For - Ghost Employees
Employees with duplicate addresses, checking accounts, or social security numbers
Employees with no withholding taxes, insurance, or other normal deductions
Purchasing & Payroll - Audit Procedures
Review selected invoices and look for evidence that the invoice has been doctored
Perform a computerized search of the vendor list and look for: P.O. Box addresses, duplicate addresses, and vendors with no phone number
Determine if vendors are listed in the yellow pages of the phone book
Perform a computerized match of the vendor list with a list of employees and look for matches of addresses or phone numbers
Perform a computerized sort of invoices by vendor and look for unusual sequencing or amount
Review selected invoices and examine supporting documentation indicating goods or services were received
Perform a computerized search of payroll records to duplicate addresses, Social Security numbers, or bank accounts
Verify Social Security numbers by calling the Social Security Administration
Review personnel files and look for those that contain little or no evidence of activity
