Henny Fausta – 2201750295 – LE53

Financial Audit 1 – Homework GSLC Week 3

Answer all of these questions :

1. Define fraud, and explain the two types of frauds that are relevant to auditors’ consideration
of fraud !
Answer :
 Fraud is an intentional act involving the use of deception that results in a misstatement of
the financial statements. In law, fraud is intentional deception to secure unfair or
unlawful gain, or to deprive a victim of a legal right.
 The two types of fraud that are relevant to auditors’ consideration of fraud :
a) Misstatement arising from misappropriation of assets
Asset misappropriation occurs when a perpetrator steals or misuses an
organization’s assets. Asset misappropriations are the dominant fraud scheme
perpetrated against small businesses, and the perpetrators are usually employees.
Asset misappropriations include embezzling cash receipts, stealing assets, or causing
the organization to pay for goods or services that the organization didn’t receive.
Asset misappropriation commonly occurs when employees :
- Gain access to cash and manipulate accounts to cover up cash thefts
- Manipulate cash disbursements through fake organizations
- Steal inventory or other assets and manipulate financial records to cover up the
fraud
b) Misstatement arising from fraudulent financial reporting
Fraudulent financial reporting is the intentional manipulation of reported financial
results to misstate the economic condition of the organization. The perpetrator of such
a fraud generally seeks gain through the rise in stock price and the commensurate
increase in personal wealth. Sometimes the perpetrator doesn’t seek direct personal
gain, but instead uses the fraudulent financial reporting to “help” the organization
avoid bankruptcy or to avoid some other negative financial outcome.
The common ways in which fraudulent financial reporting can take place include :
- Manipulation, falsification, or alteration of accounting records or supporting
documents
- Misrepresentation or omission of events, transactions, or other significant
information
- Intentional misapplication of accounting principles
 Common types of fraudulent financial reporting include :
- Improper revenue recognition
- Improper deferral of costs and expenses
- Improper asset valuation
- Concealed liabilities
- Misrepresentations or omissions in financial statement footnotes of MD&A

2. List some common incentives for managers to commit fraudulent financial reporting!
Answer:
These are the common incentives for managers to commit fraudulent financial reporting :
- Management compensation schemes
- Other financial pressures for either improved earnings or an improved balance sheet
- Debt convenants
- Pending retirement or stock option expirations
- Personal wealth tied to either financial results or survival of the company
- Greed

3. List some of the common rationalizations used by fraud perpetrators!

Answer:
“Accounting rules don’t specifically disallow it” or “the company owes me” are potential
rationales. Following are other common rationalizations used by fraud perpetrators :
- Unfair financial treatment (perceived) in relationship to other company employees
- “It is only temporary”, or “it is a loan from the company”
- “I deserve it”
- “The company is so big they won’t miss it”
- “The company is unethical”
- “The company comes by its profits in a way that exploits people”

4. What is professional skepticism ?

Answer:
Professional skepticism is an attitude that includes a questioning mind and a critical
assessment of audit evidence; requires an ongoing questioning of wether the information and
audit evidence obtained suggests that a material misstatement due to fraud may exist.
Professional skepticism is a foundation of the auditing profession that we need to maintain
and evolve to support the audit of the future.
5. Why is professional skepticism helpful for detecting fraud ?
Answer :
Professional skepticism is helpful in detecting fraud because without it the external auditor
will be easily convinced of alternative explainations to the fraud that management will
provide the conceal fraud.
The auditor’s use of professional skepticism will need to evolve with the use of technological
advancements by the profession and by clients. Skepticism will need to be applied to all
stages of the audit process, and the auditor will need to be trained to find risks and potential
errors that technology-based tools have missed.

That’s all my answer to this Homework GSLC Week 3

Thankyou

Best Regards,
Henny Fausta