DETECTING RED FLAGS
TYPES OF FRAUD
▪ Frauds committed by the corporation carry legal risk—civil,
regulatory, and criminal in nature.
▪ Broad categories of fraud:
▪ Fraudulent financial-reporting schemes
▪ Misappropriation of asset
(SAS 99 Consideration of Fraud in a Financial Statement Audit)
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FRAUD DETECTION
▪ Key procedures:
▪ Perform all procedures with an attitude of professional skepticism.
▪ Consider deception techniques during the review of documents,
including the possibility of falsified documents.
▪ Thoroughly understand and be alert to potential red flags that are
possible indicators of irregularities and likely indicators of areas
requiring further analysis.
▪ Request more documentation in fulfilling audit responsibilities. Trust
but verify.
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FRAUD RISK FACTORS
Fraudulent financial Asset
reporting misappropriation
▪
Management
characteristics Susceptibility of assets to
misappropriation
Industry characteristics
Adequacy of controls
Operating characteristics
& financial stability
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INTERPRETING POTENTIAL RED FLAGS
▪ Fraud risk factors are not the same as evidence of fraud.
▪ Fraud risk factors may indicate the existence of risks other than fraud
▪ Fraud risk factors can be ambiguous
▪ There is no linear relationship between the number of fraud risk factors
and the level of fraud risk.
▪ Fraud risk factors are of limited significance in isolation
▪ Some fraud risk factors are very difficult to observe.
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ANALYTIC PROCEDURES
▪ Evaluations of financial information made by a study of plausible relationships among both financial and non-
financial data
▪ Analytic procedures identify changes in amounts, ratios, trends, or relationships.
▪ Identify unusual transactions or events
▪ Analytic procedures are used throughout the audit process for three primary purposes:
▪ Preliminary analytic procedures
▪ Substantive analytic procedures
▪ Final analytic procedures
▪ SAS 99, Consideration of Fraud in a Financial Statement Audit, provides for “considering the results of analytic
procedures performed in planning the audit.”
▪ SAS 99 introduces disaggregated analytics to address fraud risk, particularly in revenue recognition.
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ANALYTIC PROCEDURES (CONTD…)
▪ In addition to assisting the auditor in detecting fraud, analytic procedures confer other benefits:
▪ Assessment of the entity’s ability to continue as a going concern
▪ Indication of the possible presence of errors in financial statements
▪ Implications for audit testing and procedures
▪ The following comparisons are typical aspects of analytic procedures:
▪ Current company data versus company data from prior period(s)
▪ Company data versus company budgets, forecasts, or projections
▪ Company data versus industry data and/or comparable company data
▪ Company financial data versus company operational data such as production levels, number of
employees
▪ Subset of company data versus other subset of company data: comparison of data on a disaggregated
basis such as by division, product, location, or employee
▪ Company data versus auditor-determined expected results
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ANALYTIC PROCEDURES (CONTD…)
▪ The following are the most common techniques for analyzing relationships
▪ Horizontal analysis
▪ Vertical, or common-size, analysis
▪ Comparison of the detail of a total balance with similar detail for the preceding
years
▪ Ratios and other financial relationships
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REFERENCES
▪ A GUIDE TO FORENSIC ACCOUNTING INVESTIGATION; by THOMAS W. GOLDEN, STEVEN L. SKALAK, AND
MONA M. CLAYTON; JOHN WILEY & SONS, INC
▪ Ramos, Michael (2003). Auditors’ Responsibility for Fraud Detection. Journal of Accountancy, Jan 2003,
Vol. 195 Issue 1, p28-36
