Fraud Risks to Organization
All businesses may face the risk of loss through the employees’ fraudulent activities including activities of management. The list of potential risks of fraud below is partially based on a type of fraud risks given in the old auditing standard of United Kingdom Auditing Practices Board called SAS 110 Fraud and error. You can observe that a number of the examples listed are signs of poor procedures of corporate governance, such as overcoming by one person or pressures on the internal audit and accounting departments.
Previous experience or incidents which call into question the integrity or competence of management
- Management dominated by one person (or a small group) and no effective oversight board or committee
- Complex corporate structure where complexity does not seem to be warranted
- High turnover rate of key accounting and financial personnel
- Personnel (key or otherwise) not taking holidays
- Personnel lifestyles that appear to be beyond their known income
- Significant and prolonged under-staffing of the accounting department
- Poor relations between executive management and internal auditors
- Lack of attention given to, or review of, key internal accounting data such as cost estimates
- Frequent changes of legal advisors or auditors
- History of legal and regulatory violations
Particular financial reporting pressures within an entity
- Industry volatility
- Inadequate working capital due to declining profits or too rapid expansion
- Deteriorating quality of earnings, for example increased risk taking with respect to credit sales, changes in business practice or selection of accounting policy alternatives that improve income
- The entity needs a rising profit trend to support the market price of its shares due to a contemplated public offering, a takeover or other reason
- Significant investment in an industry or product line noted for rapid change
- Pressure on accounting personnel to complete financial statements in an unreasonably short period of time
- Dominant owner-management
- Performance-based remuneration
Weaknesses in the design and operation of the accounting and internal controls system
- A weak control environment within the entity
- Systems that, in their design, is inadequate to give reasonable assurance of preventing or detecting error or fraud
- Inadequate segregation of responsibilities in relation to functions involving the handling, recording or controlling of the entity's assets
- Poor security of assets
- Lack of access controls over IT systems
- Indications that internal financial information is unreliable
- Evidence that internal controls have been overridden by management
- Ineffective monitoring of the operation of system which allows control overrides, breakdown or weakness to continue without proper corrective action
- Continuing failure to correct major weakness in internal control where such corrections are practicable and cost effective
Unusual transactions or trends
- Unusual transactions, especially near the year end, that has a significant effect on earnings
- Complex transactions or accounting treatments
- Unusual transactions with related parties
- Payments for services (for example to lawyers, consultants or agents) that appear excessive in relation to the services provided
- Large cash transactions
- Transactions dealt with outside the normal systems
- Investments in products that appear too good to be true, for example low risk, high return products
- Large changes in significant revenues or expenses
Problems in obtaining sufficient appropriate audit evidence
- Inadequate records, for example incomplete files, excessive adjustments to accounting records, transactions not recorded in accordance with normal procedures and out-of-balance control accounts
- Inadequate documentation of transactions, such as lack of proper authorization, supporting documents not available and alteration to documents (any of these documentation problems assume greater significance when they relate to large or unusual transactions)
- An excessive number of differences between accounting records and third party confirmations, conflicting audit evidence and unexplainable changes in operating ratios
- Evasive, delayed or unreasonable responses by management to audit enquires
- Inappropriate attitude of management to the conduct of the audit, eg time pressure, scope limitation and other constraints
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