Dr. Sawsan S. Halbouni

Assistant Professor

University of Sharjah

Fraud has traditionally been defined into two

broad categories: defalcations and financial

reporting fraud.

A common denominator in all fraud is the

intent to deceive for personal benefit.

Fraud is differentiated from errors by the

intent to deceive.

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defalcations o Due to corruption o Due to asset misappropriation

financial reporting fraud o Manipulation, falsification, or alteration

o Misrepresentation or omission of events

o Intentional misapplication of accounting principles.

The existence of fraud is not

confined to large companies,

nor is it confined to top

executives. It includes fraud

perpetrated by all employees

within an organization

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For example, Ernst & Young recently estimated

that 85 percent of the worst frauds were

conducted by insiders on the payroll.

A 2002 study by the Association of Certified

Fraud Examiners (ACFE) looked at the

broad nature of frauds in the United

States concludes that:

"six percent of revenue is lost as a result of fraud." That estimate translates into losses of $600 billion per year.

Those numbers do not include the losses that investors incurred on major financial reporting frauds such as Enron (estimated to be near $90 billion).

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In 2002, the Auditing Standards Board (ASB) of the AICPA issued SAS 99 on "Fraud in a Financial Statement Audit.”

The standard requires auditors to provide reasonable assurance that material fraud will be detected.

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The standard recognizes that there are fraud risk factors that the auditor should search for on every

engagement. If those fraud risk factors are present, the auditor needs to modify

the audit to:

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(a) actively search for the existence of fraud,

(b) require more substantive audit evidence, and;

(c) in some cases, assign forensic (fraud) auditors to analyze the accounts that may contain fraudulent activities.

The standard further

reemphasizes the need for

professional skepticism on

every audit engagement even

those in which the auditor has

great familiarity with the client

and its management.

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Society trusts financial statement

auditors to exercise professional

skepticism in conducting the audit.

Therefore, the auditor must

maintain an attitude of professional

skepticism concurrently with a

working level of trust during the

course of the audit.

When the auditors are unable to

successfully sustain

professional skepticism, the

results can be financial losses

to individuals relying on

financial statements, and

potentially, litigation.

Professional Skepticism is an

attitude that includes a

questioning mind and critical

assessment of audit evidence.

Professional Skepticism

requires the questioning of

whether the information and

audit evidence obtained suggest

that a material misstatements

due to fraud may exist.

Skeptical behaviors have an

ideal impact on audit quality.

Both professional skepticism

and trust are important in

financial statement audit.

Trust and professional

skepticism form an uneasy

relationship that must be

skillfully balanced.

The auditor must maintain

optimal levels of trust and

professional skepticism during

the course of audit.

Trust is a practical necessity

for the efficient conduct of the

audit.

The auditor applies professional

skepticism to the financial

statement audit in determining

the appropriate opinion on

behalf of all individuals who

will rely on the financial

statements.

“On the one hand, to accomplish

the audit requires the

cooperation of management; on

the other hand, management is

in a position to mislead the

auditors in their quest for valid

evidence”. (The report of the Panel on Audit Effectiveness, 2000, p. 86)

Excessive levels of trust could compromise professional skepticism.

Without sufficient level of trust, the audit could not be conducted.

An optimal level of trust allows the auditor to conduct an efficient, effective audit.

Lewicki and Bunker (1995, 1996)

suggested three classes of trust:

calculus–based trust,

Knowledge–based trust; and

Identification-based trust

Identification

- based trust

Knowledge-based trust

Calculus-based trust

Level of trust

Trust and Professional Skepticism

Auditor’s predisposition of

trust

Client characteristics that

attract trust

• Client skill at influencing

perceptions of

trustworthiness

• Client as former

colleague

Characteristics of

relationship between

auditor and client

• Past cooperative

behaviour

• Advice provided in the

past

• Tenure of auditor-client

relationship

Trust

(Calculus-

based,

Knowledge-

based or

Identification-

based)

Professional

Skepticism

Processional

Standard

Firm culture of

professional

skepticism

Audit Quality

Characteristics of Skeptics

(from Hurt,et al 2003)

• Questioning mind

• Suspension of judgment

• Search for knowledge

• Interpersonal

understanding

• Self-confidence

• Self-determination

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Cooperation and trust are

mutually reinforcing-that is,

greater trust leads to more

cooperation and more

cooperation leads to greater

trust (Gambetta, 1988).

Calculus-based trust is suggested

to be the optimal level of trust

since it allows the auditor to

conduct an efficient and

effective audit. (Kopp, Lemon and Rennie, 2003)

1. the auditor’s past experience

Within and outside the auditing

realm.

2. Characteristics of client

management or staff.

3. Client behavioral consistency

(reliability, consistency

between words and deeds,

giving accurate information,

providing explanations for

decisions, openness ….).

4. Past employment with audit

firm

5. Management advisory services

(MAS).

6. The length of the auditor-

client relationship

Had a board that was dominated

by management

Either had no audit committees,

or if audit committees did exist,

they rarely met (and when they

did meet, it was usually for less

than an hour once a year)

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Did not have internal audit

departments

Most of the revenue frauds

involved premature recognition,

or fictitious recognition, of

revenue

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Were in loss situations, or nearing break-even, before committing the frauds

Had dishonest management. The CEO and/or the CFO were involved with the fraud in.

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Perpetrated the frauds over

relatively long terms, extending

two or more fiscal periods; the

average fraud approached 24

months.

Overstated revenues and

corresponding assets in over half

of the frauds involved.

Thank You