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Professional standards outline Essay

Professional standards outline the auditor’s consideration of material misstatements due to errors and fraud.

a) What responsibility does an auditor have to detect material misstatements due to errors and fraud?

The purpose of assurance engagement is enhancing the reliability of the subject matters. So it is auditor’s responsibility to provide a reasonable level to assure the financial report is true and fair.

Financial report is a data assembling which reflect the position of the business. Therefore these users, including investors, managements, shareholders and the other parties can make decision base on the information provided by the financial report. Then the information which impacts on the process of decision making for the uses of the financial report is defined as materiality (Kimmel, Carlon, Loftus, Mladenovic, Kieso, & Weygandt, 2006).

The fairness and trueness of the material is important to the users of financial reports. The major task of auditor is to identify the misstatement in the financial report. By definition, misstatement is a difference between the amounts, classification, presentation or disclosure of a reported financial report item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. There are two kinds of misstatements and they rise from error or fraud respectively (Auditing, Assurance and Ethics Handbook, 2010).

But by the limitation of auditing, financial report audit only provides reasonable assurance instead of total responsibility to the fairness and trueness of the reports. The auditors can assure about whether the financial report is prepared in all material respects in accordance with a financial reporting framework. The reason of the limitation is determined by the nature of financial reporting, the nature of audit procedures and the need for the audit to be conducted within a reasonable period of time and at a reasonable cost (Moroney, Campell, & Hamilton, 2011).

b) What two main categories of fraud affect financial reporting?

By definition, fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage. These two main categories of fraud are financial reporting fraud and misappropriation of assets fraud.

Generally say misappropriation of assets fraud involves some form of theft. Therefore misappropriation of assets fraud will decrease the assets and increase the expenses then it will reduce the owner’s equity of the company (Auditing, Assurance and Ethics Handbook, 2010).

Financial reporting fraud is intentionally misstating items or omitting important facts from the financial report (Moroney, Campell, & Hamilton, 2011). In Cendant case, the fraud is the accounting department manipulating the revenues to meet the expectation of Wall Street analyst. Than the company can have more opportunities to merge other companies. The affect of the financial reporting fraud will increase sales therefore increase the profit of the company. The financial reporting with fraud will indicate the future earning ability to the share market therefore rising the share price in the exchange market.

c) What types of factors should auditors consider when assessing the likelihood of material misstatements due to fraud?

First the auditors should consider the company economical environment to identify whether there are incentives and pressures to commit a fraud (Moroney, Campell, & Hamilton, 2011). CUC is in the travel service industry which is highly competitive. And CUC’s revenue has dramatic doubled in the mid-1990s. To merge the other company, the company’s profit has to keep increasing to meet the analysts’ expectation. So the managements of CUC have pressures to create more profit by fraud financial figures.

Second the auditors should look into the financial report whether there are opportunities to perpetrate a fraud. (Moroney, Campell, & Hamilton, 2011) In this case, CUC made various year-end adjustments to the general ledger. Those significant adjustments created great opportunities to make a fraud.

Finally, attitudes and rationalisation to justify a fraud need to be assessed by the auditors. (Moroney, Campell, & Hamilton, 2011)CUC has been required to amend its financial statements by the Securities and Exchange Commission several times for using aggressive accounting practices in later 1980’s and early 1990’s. And from CUC’s high speed expand, the companies top management showed high enthusiasm to maximise the share price. So the top level managements have created a flexible environment for the financial fraud.

d) Which factors existed during the 1995 through 1997 audits of CUC that created an environment conducive for fraud?

Seeking the incentives and pressures to commit a fraud, material stated in the early and mid-1990’s CUC acquired several companies to expand market share. Those acquisitions included Entertainment Publications in 1992, Net Market in 1994, Welcome Wagon International, Home Shopping Travel Club, Privacy Guard in 1995, Sierra On-Line, Davidson & Associates in 1996. CUC also came into the new contracts with big companies such as Intel, Time Warner and American Airlines. CUC had doubled revenues from 738m in 1993 to 1.4b in 1996 and at same time CUC’s net income rose from 25m to 163m (CUC International Inc. – Company Profile, Information, Business Description, History, Background Information on CUC International Inc.).

CUC was in highly increasingly competitive industry. To maintain high growth rate hut pressures on the managements.

However, for year-end reporting purposes, CUC made various year-end adjustments to incorporate the misstatements into the general ledger. Those adjustments are the opportunities to perpetrate a fraud.

Question 2:

Entity’s 5 interrelated components of internal control

a) What responsibility does an auditor have related to each of these five components?

Internal control is the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations.

Internal control framework is one of the independent reference for auditors to gather. The auditors need to test the five components of the internal control to identify the level of risk to error or fraud. The auditors need to test the effectiveness, consistent, inspection of documents for evidence of authorisation, inspection of documents for evidence that details included have been checked by appropriate client personnel, personnel performing,how they perform their tasks and re-performing control procedures.

1) The control environment

The control environment is the attitudes, awareness and action of management and those charged with governance concerning the entity’s internal control and its importance in the entity. And the control environment sets the foundation for effective internal control, providing discipline and structure and includes several elements such as, communication and enforcement of integrity and ethical values, commitment to competence, participation by those charged with governance, management’s philosophy and operating style, organisational structure, assignment of authority and responsibility, human resource policies and practices.

The auditor should consider each of these areas and their interrelationships. Especially, the auditor need to identify the significant deficiencies.

2) The entity’s risk assessment process

The entity’s process for identifying and responding to business risks, in the financial reporting area, is how management find risks in the preparation of a financial report that is true and fair.

There are three kinds of risks, inherent, control and detection risks. Inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls. Control risk is the risk that a client’s system of internal controls will not prevent or detect a material misstatement. Detection risk is the risk that the auditor’s testing procedures will not be effective in detecting a material misstatement. And auditors need to assess the combined inherent, control and detection risks to evaluate the risk of the material misstatements.

3) The information system, including the related business processes, relevant to financial reporting, and communication. The role of information systems is to capture and exchange the information needed to conduct, manage and control an entity’s operations. Auditors will test the information system related to the financial reporting objectives as same as initiating and recording transactions, balance and events.

4) Control activities

Policies and procedures that help ensure that management directives are carried out. An audit need to categorise activities such as performance reviews, information processing, physical controls, segregation of incompatible duties. Those activities are easier to be test by the auditors compare those entity-level control activities.

5) Monitoring of controls

After establishing and maintaining internal controls, an important responsibility of management is to monitor the controls to assess whether they are operating as intended and modified for changes in conditions on a timely basis.

An audit needs to collect evidence about the design and effectiveness of internal controls. Those considerations include periodic evaluation, person in charge, communication channel, management implements, correcting significant deficiencies, implements reports and recommendations from regulators, function of internal audit and evaluations or observations made by the external auditors (Moroney, Campell, & Hamilton, 2011).

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