The auditor and fraud risk

Accounting Ahead | Original study resource | accountingahead.com.au

The auditor and fraud risk

MODULE 2 | 2.6.1 | STUDENT COMPANION

Fraud is intentional; error isn't. The fraud standard focuses on two kinds: fraudulent financial reporting

(deliberately misstated statements) and misappropriation of assets (theft). Management and those

charged with governance carry the primary responsibility for preventing and detecting fraud; the auditor

seeks reasonable assurance that the statements are free of material misstatement, whether from fraud or

error, knowing that fraud is harder to find. The fraud triangle shows where to look. Revenue fraud risk is

presumed unless rebutted, and management override is always a significant risk, met with three

responses on every audit.

Fraud or error?

Error Fraud

Intent Unintentional Intentional, involving deception to gain an unjust or

illegal advantage

Examples A data-processing slip; an estimate wrong

through oversight; a misread accounting

standard

Fictitious sales; hidden liabilities; stolen stock;

payments to a fake supplier

Who Anyone involved in the process Management, employees or outsiders, sometimes

acting together

How it hides It usually doesn't: the trail is still there By design: forged documents, collusion,

transactions deliberately left unrecorded

Two kinds of fraud, side by side

Error

Unintentional

The difference is intent Fraud

Intentional, involving deception

Fraudulent financial reporting

Deliberately misstating or leaving out amounts or

disclosures to deceive users

Recording fictitious sales

Hiding liabilities

Manipulating estimates

ACFE surveys: least common kind, but the largest losses per case

Misappropriation of assets

Stealing the entity's assets, usually concealed with false

records

Stock and cash

Payments to fake suppliers

ACFE surveys: by far the most common kind of occupational fraud

Both now travel through digital channels too: fake invoices sent by email, hacked payment systems

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | STUDENT COMPANION

1

Accounting Ahead | Original study resource | accountingahead.com.au

Digital channels. Both kinds of fraud increasingly arrive online: a fake invoice emailed from what looks like a

regular supplier, a request to change a supplier's bank details, or a payment system taken over by hackers.

How often, and how costly. The Association of Certified Fraud Examiners' surveys keep finding the same

pattern: theft of assets is by far the most common kind of fraud by people inside an organisation, while financial

statement fraud is the least common but causes the largest losses per case.

Source: Association of Certified Fraud Examiners, Occupational Fraud 2026: A Report to the Nations (14th edition).

Who is responsible?

Management, and those charged with governance Auditor

Primary responsibility for preventing and detecting fraud Reasonable assurance that the statements as a whole

contain no material misstatement, whether from fraud or

error

Build an honest, ethical culture, and run controls that

prevent fraud or catch it quickly

Identify and assess fraud risks, respond to them, and

keep a sceptical mind throughout, whatever past

experience suggests about the client's honesty

Oversight by the board, including of management's own

fraud risk assessment

Accept the limits: fraud is built to be hidden, so a material

fraud is harder to find than an error, and harder still when

management is involved

The fraud triangle at Voltana

None of these proves fraud. Together, they

show where to look hardest.

Incentive or pressure

Executive bonuses depend on 30% revenue growth

The market has been told to expect strong growth

Bank loan conditions must keep being met

Opportunity

The founder dominates decision-making

New system live mid-year; controls still settling in

Sales staff can submit installation forms themselves

Transactions with the chief executive's own property

company

Attitude or rationalisation

A sales manager thinks: 'We'll install it next week anyway,

so recording the sale now does no harm.'

Rarely visible in documents: the auditor listens for it in

conversations

Reading the triangle. Pressure and opportunity are visible from outside; rationalisation rarely is, which is why

the auditor listens for it in conversations. At Voltana every corner is present, and they point to the same place:

revenue recorded before installation, where a sales manager's rationalisation meets a bonus scheme and forms

that sales staff can submit themselves.

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | STUDENT COMPANION

2

Accounting Ahead | Original study resource | accountingahead.com.au

Case note: Steinhoff

Steinhoff was a global retail group with businesses in Europe, Africa, the United States and Australia, built up

through rapid acquisitions. In December 2017 it announced accounting irregularities that needed investigation,

and its chief executive resigned. Its share price collapsed by more than 60% in a single day and kept falling. A

forensic investigation later reported that a small group of former executives had arranged transactions over

many years that inflated the group's profits and asset values, with irregular transactions totalling about EUR 6.5

billion between 2009 and 2017. The pattern: pressure from a growth story the market loved, opportunity from a

powerful leader and a complex web of entities, and transactions designed to look legitimate to anyone who didn't

trace them all the way through.

Source: Steinhoff International Holdings announcement (5 December 2017); overview of PwC's forensic investigation (15 March 2019).

What the fraud standard requires on every audit

1. Team discussion

How and where could the statements be

misstated through fraud?

2. Enquiries

Management, those charged with

governance, internal audit and other staff:

known or suspected fraud, and how fraud

risk is managed

3. Risk factors and analytics

Fraud risk factors, and unusual relationships

found by analytical procedures

Then two presumptions apply

Revenue recognition: fraud risk presumed

Rebut only with documented good reasons, e.g. simple rent from a

single property

Management override: always a significant risk

It can never be rebutted

Test journal entries

Especially at period end: unusual

users, odd times, rarely used

accounts, round amounts

Review estimates for bias

Including how last year's estimates

turned out

Question unusual deals

Significant transactions outside

the usual business: a sound

business reason, or built to flatter

the accounts?

Plus unpredictability

Test locations, accounts or timing

the client doesn't expect

Rebutting the revenue presumption. The auditor can conclude that revenue carries no fraud risk only with

good, documented reasons, typically where revenue is simple, predictable and leaves management almost no

room for judgement, such as fixed rent from a single property. The conclusion can differ between revenue

streams, and the reasons go on the file. The revised ASA 240, for periods beginning on or after 15 December

2026, keeps both presumptions.

Why test journal entries when nothing looks wrong? Management override leaves few traces until someone

looks, and journal entries are one of the main tools for it: a manual entry can move profit between years, inflate

revenue or bury an expense. So the standard requires the test on every audit, whatever the risk assessment

says. The team first checks that the list of journals is complete, by reconciling it to the general ledger, and then

selects entries with the features of override.

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | STUDENT COMPANION

3

Accounting Ahead | Original study resource | accountingahead.com.au

Practice questions

MODULE 2 | 2.6.1 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Sort the fraud risk factors

Mirrabook Facility Services Ltd (imagined) is listed and runs cleaning and maintenance contracts for offices,

shopping centres and universities. Sort each fact into incentive or pressure, opportunity, or attitude and

rationalisation.

Fact Incentive, opportunity or

attitude?

(a) The chief executive's bonus doubles if revenue passes $300 million this year

(b) The finance director approves new suppliers and can also release payments alone

(c) The chief operating officer says bending accounting rules is 'what everyone in this

industry does'

(d) Lenders require gearing below a set limit, and the company is close to it

(e) The internal audit role has been vacant for nine months

(f) Two long-serving site managers say they 'deserve a bit extra' after a two-year pay

freeze

(g) Analysts expect 15% earnings growth, and the share price already assumes it

(h) Month-end accruals for unbilled work are calculated by one finance officer, with no

review

(i) Management dismissed last year's audit findings on payment controls as 'red tape'

(j) The group has 14 subsidiaries, several set up this year with no clear business

purpose

(k) The chief executive has a large personal loan secured over company shares

(l) Management often argues that disputed adjustments are 'too small to matter'

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | STUDENT COMPANION

4

Accounting Ahead | Original study resource | accountingahead.com.au

Question 2 - Three tests of journal entries

Design three tests of Mirrabook's journal entries and explain what each would detect.

Test you would run on Mirrabook's journal entries What it would detect

Question 3 - Can the property trust rebut the presumption?

Keswick Industrial Property Trust (imagined) owns five warehouses, each let to one unrelated tenant on a long

lease. Rent is fixed in each lease, rises by 3% a year, is invoiced monthly in advance and is paid by direct debit.

There is no turnover-based rent. The trust has no employees; an outside manager runs it for a fee based on the

value of the properties. In May, the trust waived three months' rent for one tenant in return for a two-year

extension of its lease. Could the auditor rebut the presumed risk of fraud in revenue recognition? What would

you document?

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | STUDENT COMPANION

5

Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 2 | 2.6.1 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Mirrabook Facility Services

Category Why

(a) Incentive A personal reward tied to a revenue target

(b) Opportunity Incompatible duties: one person can create a supplier and pay it

(c) Attitude A ready-made excuse for misstating the accounts

(d) Incentive Pressure to meet a lender's condition

(e) Opportunity Weak monitoring: nobody independent is checking

(f) Attitude A sense of entitlement that can justify theft

(g) Incentive Pressure to meet outside expectations

(h) Opportunity A judgemental figure prepared and controlled by one person

(i) Attitude Disregard for controls and for the auditor

(j) Opportunity A complex, changing structure in which transactions can be hidden

(k) Incentive Personal financial pressure linked to the share price

(l) Attitude Repeatedly justifying doubtful accounting on materiality grounds

Question 2 - Journal entry tests (suggested)

Test What it would detect

Manual entries to revenue, accrued income or receivables

in the last two weeks of the year and the first two after it

Revenue or unbilled work recorded early, or invented, to

reach a target, especially if reversed soon after year end

Entries posted by senior people who rarely post (the chief

executive, the finance director), by IT staff, or at weekends

and late at night

Override by people able to bypass normal approval, and

entries kept away from routine review

Round-amount entries, entries with blank or vague

descriptions, and entries to rarely used or suspense

accounts

Plugs and manipulations, such as moving costs between

accounts or into the balance sheet

First, for every test Reconcile the journal listing to the general ledger so the

population is complete; then inspect support, check

approval and ask why each entry chosen was needed

Question 3 - Keswick Industrial Property Trust (sample answer)

Mostly yes. Rent on the four unchanged leases is fixed, predictable, paid by direct debit and easy to recalculate,

and the manager's fee depends on property values, not revenue. Rebutting the presumption for that stream is

reasonable.

Not for the changed lease. The rent waived must be spread over the new lease term, a judgement that is easy

to bend in a flattering direction, so keep the presumed risk for this stream, or test it closely.

Document the reasons and evidence (leases inspected, rent recalculated, receipts traced), the treatment of the

changed lease and when to revisit the conclusion. Substantive work on rent and the three responses to

management override still apply.

ADVANCED AUDIT AND ASSURANCE | M2 | 2.6.1 | WORKED ANSWERS

6