BUS 425 – auditing GSA 552 – fraud auditing & examination

1. BUS 425 – auditingGSA 552 – fraud auditing & examination Advisory Board Meeting November 30, 2012

2. Bus 425 - auditing 10 Auditing Standards Managements’ Assertions Standard Auditor’s Report Audit Risk Model audit approaches

3. Auditing Standards Tad’s Favorites The BIG 3

4. Ron What is the second general standard ?

5. 2nd general standard The auditor must maintain independence in mental attitude in all matters relating to the audit ties to chapter on Independence and professional ethics

6. ties to chapter on Internal Control and SOX 404 audits 2ndStd of Field Work must understand the entity and its internal controls to assess the RoMM 3rdStd of Field Work sufficient, appropriate evidence Relates to audit procedures Sales Accounts Receivable Cash Receipts Cash Relates to Legal liability Statistics / Sample Size

8. Did the Sale really occur? Was the Sale reported in the correct period? Does the Receivable actually exist? Is the Allowance properly valued? Were the Cash Receipts recorded in the correct period? We really only cover the Sales / Collection cycle

9. standard auditor’s report Qualified Opinion Disclaimer of Opinion We have audited the accompanying balance sheet of Miller Motor Co. as of Dec. 31, 2012 and 2011, and the related statements of income, retained earnings and cash flows for the three years ended Dec. 31, 2012. These statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Miller Motor Co. as of Dec. 31, 2012 and 2011, and the results of its operations and cash flows for the year then endedin conformity with accounting principles generally accepted in the United Stated. Qualified Opinion Adverse Opinion Did we Obtain Sufficient Appropriate Evidence from our Audit Procedures? Qualified and Qualified Are two very different opinions Do the financial statements present fairly?

10. 4th standard of reporting The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor’s report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefor in the auditor’s report. In all cases where the auditor’s name is associated with financial statements, the auditor should clearly indicate the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking, in the auditor’s report if issuing a disclaimer of opinion

11. Bus 425 – audit risk model verbal acknowledgement is given to KPMG when using this slide

12. Reduced Level of Control Risk approach extensive Tests of Controls Audit Risk Model Primarily Substantive approach extensive Substantive Tests

13. Private Company

14. Public Company

15. GSA 552 – fraud auditing & examination ISA 240 – the auditor’s responsibility relating to fraud AU 316 – Consideration of fraud in financial state audit Textbook – Albrecht, et al Articles – Journal of Accountancy, Wall Street Jnl, etc. Case studies Videos IDEA audit software

16. ISA 240 Professional Skepticism Discussion among the Engagement Team Risk Assessment Procedures and Related Activities Managements and Others within the Entity Those Charged with Governance Unusual or Unexpected Relationships Identified Other Information Evaluation of Fraud Risk Factors Identification &Assessment of the RoMM Due to Fraud Responses to the Assessed RoMM Due to Fraud Overall Responses at the Financial Statement Level Responses to Assessed RoMM Due to Fraud at the Assertion Level Responses to Risks Related to Management Override of Controls Evaluation of Audit Evidence Auditor Unable to Continue the Engagement Written Representations Communications to Mgmt& with Those Charged with Govern Communications to Regulatory and Enforcement Authorities Documentation

17. AU 316 ISA 240 Overall Responses to the Risk of Material Misstatement Responses Involving the Nature, Timing, and Extent of Procedures Responses to the Risk of Management Override of Controls Overall Responses at the Financial Statement Level Responses to RoMM at the Assertion Level Responses to the Risk related to Management Override of Controls

18. Revenue / Management Override When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue Although the level of risk of management override of controlswill vary from entity to entity, the risk is nevertheless present in all entities. Due to the unpredictable way in which such override could occur, it is a risk of material misstatement due to fraud and thus a significant risk.

19. Fraud Triangle Incentives/Pressures Opportunities Attitudes/Rationalizations

20. GSA 552 – fraud auditing & exam each day 11/2–2 hours lecture from textbook / assignment 1 hour case discussion 1 hour video or 2 hours IDEA audit software

21. GSA 552 – fraud auditing & exam

22. Sales Collection cycle Accounts Receivable 100 Sales 100 Cost of Goods Sold 60 Inventory 60 Cash 100 Accounts Receivable 100 We build on what we covered in Auditing But add Cost of Goods Sold / Inventory

23. Did the Sale really occur? Was the Sale reported in the correct period? Does the Receivable actually exist? Is the Allowance properly valued? Were the Cash Receipts recorded in the correct period? Does the Inventory exist? Is inventory valued at LoCM? Did the Purchases occur? Do purchases support reported sales? Are Inventory quantities realistic given reported sales?

24. The purpose of the cases • background for class discussions. • develop an awareness of different kinds of fraud schemes: • fraudulent financial reporting • misappropriation of assets

25. The purpose of the cases http://clubs.cob.calpoly.edu/~cmiller/ACTG%20552%20page%20.html

26. TEXT AND RESOURCES Albrecht, W.S., C.O. Albrecht, C.C. Albrecht and MF. Zimbelman (2012). Fraud Examination, 4th edition. South-Western Cengage Learning. ISBN: 978-0-538-47084-1 AICPA (February 2010). Codification of Statements on Auditing Standards, AU Section 316: Consideration of Fraud in a Financial Statement Audit. American Institute of Certified Public Accountants, New York, NY. Armstrong, M.B. (1997). (Parker Bros.: An Accountancy Corp.) in Ethics and Professionalism for CPAs.Thompson Southwestern. Bunge, J., S. Patterson and J. Steinberg (July 14, 2012) Peregrine CEO’s Dramatic Confession. The Wall Street Journal. Caplan, D.H., S.K. Dutta and D.J. Marcinko (2012). Lehman on the Brink of Bankruptcy: A Case about Aggressive Application of Accounting Standards. Issues in Accounting Education, Vol. 27, No. 2, pp. 441-459. Coe, M.J., J. Coussens and J. Delaney (May/June 2009). Something’s Fishy at Jones Company: Classroom Case Takes Auditors from Investigation to Confession. Fraud Magazine. Cohn, Michael (July 23, 2012) Audit Confirmations Helped Unmask Peregrine Fraud. Accounting Today. Cunningham, G.M. and J.E. Harris (2006). Enron and Arthur Andersen: The Case of the Crooked and the Fallen A. Global Perspectives on Accounting Education. Vol. 3, pp. 27-48. Dugan, I.J. and M. Rothfeld (July 20, 2012). Peregrine’s Vast Money Trail. The Wall Street Journal Fox, Loren (2003). (Chapter 7: Taking the Plunge) in Enron. John Wiley & Sons, Inc. Hoboken, New Jersey. Howe, H. and R.H. Gifford, Grumley Nano Tech: Risk Assessment in Audit Planning. unpublished working paper. International Auditing and Assurance Standards Board (2004). International Standard on Auditing 240: The auditor’s responsibility relating to fraud in an audit of financial statements. McKnight, C.A., T.S. Manly and P.S. Carr (May 2008). Maxwell and Company: Staff Auditor Embezzlement at a Small Client. Issues in Accounting Education, Vol. 23, No. 2, pp. 291-297. Peterson, B.K. and T.A. Buckhoff (November 2004). Interstate Business College: A Case Study in Fraud Examination. Issues in Accounting Education, Vol. 19, No. 4, pp. 505-527. Porter, Jason C., (May/June 2009). How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co. Issues in Accounting Education Vol. 27, No. 2, pp. 493-524. Ramos, Michael (Jan. 2003). Auditors’ Responsibility for Fraud Detection, Journal of Accountancy. Rueters (??? 2012) Peregrine CEO charged with lying to regulators. Waterloo Courier. Rueters (2012, July 12) U.S. probing failed broker PFGBest’s use of small auditor. Chicago Tribune Savage, A and T. Miller. Fraud in Financial Statements: Olympus. unpublished working paper. Thomas, C. William (April 2002). The Rise and Fall of Enron, Journal of Accountancy. Weirich, T.R. and R.L. Crawford (2012) Vision Services, Inc. Accounts Receivable Reporting Fraud. Journal of Forensic & Investigative Accounting, Vol. 4, Issue 1. Wells, Joseph T., (February 2002). Lapping it Up, Journal of Accountancy.

27. RESOURCES AICPA (February 2010). Codification of Statements on Auditing Standards, AU Section 316: Consideration of Fraud in a Armstrong, M.B. (1997). (Parker Bros.: An Accountancy Corp.) in Ethics and Professionalism for CPAs.Thompson Southwestern. Bunge, J., S. Patterson and J. Steinberg (July 14, 2012) Peregrine CEO’s Dramatic Confession. The Wall Street Journal. Caplan, D.H., S.K. Dutta and D.J. Marcinko (2012). Lehman on the Brink of Bankruptcy: A Case about Aggressive Coe, M.J., J. Coussens and J. Delaney (May/June 2009). Something’s Fishy at Jones Company: Classroom Case Takes Auditors from Investigation to Cohn, Michael (July 23, 2012) Audit Confirmations Helped Unmask Peregrine Fraud. Accounting Today. Cunningham, G.M. and J.E. Harris (2006). Enron and Arthur Andersen: The Case of the Crooked and the Fallen Dugan, I.J. and M. Rothfeld (July 20, 2012). Peregrine’s Vast Money Trail. The Wall Street Journal Fox, Loren (2003). (Chapter 7: Taking the Plunge- in Enron. John Wiley & Sons, Inc. Hoboken, New Jersey. Howe, H. and R.H. Gifford, Grumley Nano Tech: Risk Assessment in Audit Planning. unpublished working paper. International Auditing and Assurance Standards Board (2004). International Standard on Auditing 240: The auditor’s responsibility McKnight, C.A., T.S. Manly and P.S. Carr (May 2008). Maxwell and Company: Staff Auditor Embezzlement at a Small Client. Peterson, B.K. and T.A. Buckhoff (November 2004). Interstate Business College: A Case Study in Fraud Examination. Porter, Jason C., (May/June 2009). How Adjusting Entries Affect Quality of Financial Reporting: Frosty Ramos, Michael (Jan. 2003). Auditors’ Responsibility for Fraud Detection, Journal of Accountancy. Rueters (??? 2012) Peregrine CEO charged with lying to regulators. Waterloo Courier. Rueters (2012, July 12) U.S. probing failed broker PFGBest’s use of small auditor. Chicago Tribune Savage, A and T. Miller. Fraud in Financial Statements: Olympus. unpublished working paper. Thomas, C. William (April 2002). The Rise and Fall of Enron,Journal of Accountancy. Weirich, T.R. and R.L. Crawford (2012) Vision Services, Inc. Accounts Receivable Reporting Fraud. Journal of Wells, Joseph T., (February 2002). Lapping it Up, Journal of Accountancy.

29. The purpose of the videos • break up class sessions • convey information about various types of fraud schemes • minimal input on the part of students

30. The purpose of the videos http://clubs.cob.calpoly.edu/~cmiller/ACTG%20552%20page%20.html

31. The purpose of the videos Corporate Con:Tony 6:00; John11:30; Kay15:45; McKinley19:50; Beyond the Numbers:Interviewing Techniques Cooking the Books:ZZZZ Best; Regina; ESM How to Detect and Prevent Financial Statement Fraud Finding the Truth:effective techniques for interview Fraud Trial Investment Swindles and Con Schemes Making Crime Pay: how to locate hidden assets Other People's Money:basics of asset misappropriation

33. The purpose of IDEA audit software • Access, combine and manipulate data from various sources • Relate the tests performed using IDEA software to assertions we learned in auditing class. • Reinforce concepts covered in GSA 552

34. IDEA audit software Three Projects Accounts Receivable Accounts Payable Inventory

35. IDEA audit software Import data from Database files Text files Excel files Import, combine and manipulate the data

36. Accounts Receivable Import and merge data from database & text files Customers exceeding credit limits High value accounts Old invoices Select a random sample Benford test of leading digits

37. Accounts Payable Import and merge data from excel & text files Payments to unauthorized suppliers Duplicate payments & duplicate supplier addresses Purchases and payments for round dollar amounts Payments made sooner than policy Purchases just below authorization limits Persons making questionable transactions

38. Inventory Import data from ASCII file Calculate inventory turnover Calculate turnover bands by product Months of inventory on hand Inventory aging Re-order point errors Provision for obsolete inventory Negative profit items

41. Jim Anderson Earl Keller 10 Kate Lancaster Tad Miller 9 Bobbi Jones Doug Cerf 8 Eddy Quijano retired 7 Arline Savage 6 Garo Kalfayan 5 Jap Efendi 4 Andreas Simon 3 Li Dang still here 2 Rodney Mock still here 1 Jeff Tolin

42. Audit Risk Model