Transcript Seminar on handling tax queries

Seminar on
Fraud Detection
Presented by Candice Lau
on 25 March 2011
T. K. Lo & Company, CPAs
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What is Fraud?
• Crime of cheating somebody in order to
get money or goods illegally (Source:
Oxford Dictionary)
• Intentional act by one or more individuals
among management, those charged with
governance, employees, or third parties,
involving the use of deception to obtain an
unjust or illegal advantage
(Adapted from HKSA 240 para11(a))
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Types of Fraud
Relevant to Auditors
• Fraudulent financial reporting, and
• Misappropriation of assets
Both result in misstatement of financial
statements!!!
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Fraudulent
Financial Reporting
• Omission of accounts or disclosures in F/S
• Often involves management override of
controls
• Example: By the effort of management to
manage earnings in order to deceive F/S
users by influencing their perceptions as to
the entity’s performance and profitability
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Fraudulent Financial
Reporting (Continued)
• Techniques:
 fictitious journal entries
 inappropriately adjusting assumptions
 omitting, advancing or delaying
recognition
 concealing, or not disclosing, facts
 engaging in complex transactions
 Altering records and terms
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Misappropriation of Assets
• Theft of entity’s assets
• Often involves employees in small and
immaterial amounts
• Accomplished by:
 embezzling receipts
 stealing physical assets or intellectual
properties
 paying for goods or services not received
 using entity’s assets for personal loan
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Who Commits Fraud?
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Suppliers
Competitors
Customers
Officers
Managers
Employees
Directors
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Fraud News from
United States
Source: 2010 Report to the Nation on Occupation Fraud & Abuse,
Association of Certified Fraud Examiners
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Elements of Fraud
Fraud Triangle
Pressure / Incentive
Opportunity
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Rationalization
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Fraud Triangle
- Pressure / Incentive
Operating conditions:
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High degree of competitions
Decline in customer demand
Operating losses
Negative cash flows
New accounting or statutory requirements
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Fraud Triangle
- Pressure / Incentive (Continued)
Meeting expectation of third parties
• Profitability level expected by investors,
creditors, or management
• Obtaining additional debt or equity financing
• Debt covenant requirements
• Business combinations or contract awards
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Fraud Triangle
- Opportunities
• Weak internal control
• Poor management oversight
• Domination of management without
compensating controls
• Unduly complex organizational structure
• High turnover of employees
• Low chance of being caught
• Small penalty of being caught
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Fraud Triangle
- Rationalization
• Believe that committing fraud is the only
solution to problems
• Label theft as “borrowing”
• Because of job dissatisfaction
• Does not understand / care about
consequence of the action
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Red Flags
Something different than expected as to
time, frequency, place, amount or
personality
Difference may be very small, however,
when accumulated, often the essence
of a sophisticated fraud scheme
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Operational / Business
Red Flags
• Loose internal controls
• Poor computer file access & password
controls
• Unrealistic earning targets
• Override of normal controls by
management-officers
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Operational / Business
Red Flags (Continued)
• Significant or unusual changes in
customers or suppliers
• Significant related party transactions
• Highly complex transactions near year
end
• Significant bank accounts in tax-havens
with no apparent business justification
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Operational / Business
Red Flags (Continued)
• Transactions which lack documentation
or normal approval
• Unusually rapid growth or profitability
• Inability to generate cash flow
• Poor or deteriorating financial position
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Red Flags –
Inventory & Purchase
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Excessive inventory
Large inventory adjustments
Deviation from specifications
Delivery location = employee address
Most contracts awarded to a particular
supplier
• New supplier with P O Box address
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Red Flags –
Accounts Payable
• Invoices are duplicates or copies
• Altered or missing supporting
documents
• Unusual payees
• Duplicate payments
• Vendor address = employee address
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Red Flags –
Cash Receipts & Receivables
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Shortage and overages in cash drawers
Excessive voids or refunds
Slow deposits in transit
Increasing debtors / sales ratio
Bad debts all centered on 1 employee
Sudden loss of customers
Customers complained “ I paid”
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Red Flags –
Payroll
• Authorization do not match signatures
on file
• Supervisors fill out time sheets
• Excessive overtime
• Employees not present to get cheques
• Level of wages inconsistent with level of
production
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HKSA 240
• Hong Kong Standard on Auditing 240
The Auditor’s Responsibilities Relating
to Fraud in an Audit of Financial
Statements
(Issued July 2009; revised July 2010)
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HKSA 240
- Requires Auditors to:
• Maintain attitude of professional skepticism
• Discuss the susceptibility
• Perform procedures to identify and assess
risks of material misstatements due to fraud
• Determine overall responses to address to
the risks
• Design and perform audit procedures
response to risks of fraud
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HKSA 240
- Requires Auditors to: (Continued)
• Consider whether identified misstatement is
indicative of fraud
• Obtain written representations relating to
fraud
• Communicate with management and those
charged with governance
• Establish documentation requirements
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Professional Skepticism
• Maintain throughout the audit
• Recognizing possibility of existence of
material misstatement due to fraud
• Notwithstanding past experience with the
entity
• May accept records and documents as
genuine unless indications of contrary
• Investigation to inconsistencies
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Discussion among
Engagement Team
• Discuss susceptibility of client’s financial
statements to material misstatement due to
fraud
• Engagement partner consider matters to be
communicated with team members not
involved in discussion
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Risk Assessment Procedures
• Make inquiries of management, those
charged with governance, and others as
appropriate for understanding
management’s attitude towards risk of fraud
• Consider whether fraud risk factors present
• Consider any unusual or unexpected
relationships by analytical procedures
• Consider other information
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Risks of Fraud in
Revenue Recognition
• Risk greater due to pressures from
performance measurement or cash sales
• Overstatement of revenue: premature
revenue recognition, fictitious revenue
• Understatement of revenue: improper
shifting revenue to a later period)
• Above presumption may be rebutted for
cases with single type of simple revenue
• If presumption not applicable: state reason
(para 47)
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Overall Responses to
Assessed Risks
• Increase sensitivity in selection of nature and
extent of documentation to be examined in
support of material transactions
• Increase recognition of need to corroborate
management explanations or
representations concerning material matters
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Audit Procedures
• At assertion level:
 Physical observation or inspection of
important assets
 Substantive testing at or near period end
 Increasing sample sizes or performing
analytical procedures at a more
detailed level
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Audit Procedures (Continued)
• Responsive to Management Override of
Controls:
 Test the appropriateness of journal
entries made at year end
 Review accounting estimates
 Understand client’s significant
transactions which are outside normal
courses of business
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Audit Procedures (Continued)
• Evaluation of audit evidence:
 Evaluate whether assessment of risks at
assertion level remain appropriate
 Perform analytical procedures at or near
end of audit
 Consider whether identified misstatement
may be indicative of fraud
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Audit Procedures (Continued)
• Management representations (written):
 Acknowledge responsibilities for design
and implementation of internal control to
prevent and detect fraud
 Disclose to auditors results of
assessment of risk F/S may be materially
misstated as a result of fraud
 Disclose to auditors knowledge of actual,
suspected or alleged fraud
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Communicate with
Management
• If fraud has been identified
• If information indicates fraud may exist
 Communicate as soon as possible to
appropriate level of management
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Unable to Continue
the Engagement
• Client does not take appropriate action
regarding fraud
• Results of audit tests indicate significant risk
of material and pervasive fraud
• Significant concern about competence or
integrity of management
Consider professional and legal
responsibilities (may obtain legal advice)
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Documentation
• Auditor’s understanding of client and its
environment
• Auditor’s assessment of risks of material
misstatement
• Decisions reached during discussion among
engagement team
• Auditor’s responses to assessed risks
• Results of audit procedures
• Communications about fraud made to
management
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Reference Materials
• Hong Kong Standards on Auditing 200, 230,
240, 260, 315, 330, 450, 540, 580, 610 &
700
• Website of Association of Certified Fraud
Examiners: www.acfe.com
• T. K. Lo’s Engagement Handbook V9_4
(讚！)
• ACCA seminar notes: Technical Seminar on
“Forensic Accounting” held on 1 Feb 2010
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~ The End ~
Thank You
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