Types Of Fraud:
As a broad legal concept, fraud describes any intentional deceit meant to deprive another person or party of
their property or rights.
In the context of auditing financial statements, fraud is defined as an intentional misstatement of financial
statements.
There are two main categories:
1) Fraudulent financial reporting:
o Is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users
by:
Overstate income: either by overstatement of assets and income or by omission of liabilities
and expenses
Understate income: this may be done in an attempt to reduce income taxes or to make Income
smoothing (Is a form of earnings management in which revenues and expenses are shifted
between periods to reduce fluctuations in earnings.)
o Ex: WorldCom capitalized as fixed assets billions of dollars that should have been expensed.
o Ex: Omissions of amounts are less common, but a company can overstate income by omitting
accounts payable and other liabilities.
o Ex: Reduce the value of inventory and other assets resulting in higher earnings when the assets are
later sold.
o Ex: Overstate inventory obsolescence reserves and allowances for doubtful accounts to counter higher
earning
2) Misappropriation of assets:
o Is fraud that involves theft of an entity’s assets. In many cases, but not all, the amounts involved are
not material to the financial statements.
o Misappropriation of assets is normally perpetrated at lower levels of the organization hierarchy. In
some notable cases, however, top management is involved in the theft of company assets.
o Although much of this fraud involves external parties, such as shoplifting by customers and cheating
by suppliers.
Conditions For Fraud:
Three conditions are referred to as the fraud triangle:
1) Incentives/Pressures. Management or other employees have incentives or pressures to commit fraud.
2) Opportunities. Circumstances provide opportunities for
management or employees to commit fraud.
3) Attitudes/Rationalization. An attitude, character, or set of
ethical values exists that allows management or employees
to commit a dishonest act, or they are in an environment that
imposes sufficient pressure that causes them to rationalize
committing a dishonest act.
Application of the Three Conditions on Fraudulent financial reporting with examples:
Application of the Three Conditions on Misappropriation of assets with examples:
Assessing The Risk Of Fraud:
