What are examples of fraud risk factors relating to misstatements arising from fraudulent financial reporting?

 

Fraudulent financial reporting means intentional misstatements, including omissions of amounts or disclosures in financial statements with the aim to deceive financial statement users

Fraud risk factor are events or conditions that indicate an incentive or pressure to commit fraud or provide an opportunity to commit fraud.

Auditors may face with fraud risk factors in different rage of situations. Fraud risk factors usually are

classified based on the three conditions generally present when material misstatements due to fraud take place:  incentives/pressures, opportunities, and attitudes/rationalizations.

 The following are examples of fraud risk factors when material misstatements due to fraud take place

Incentives/pressures

It relates to situations when financial stability or profitability is threatened by economic, industry, or company operating conditions:

•   New accounting, statutory, or regulatory requirements.
•    High degree of competition or market saturation, accompanied by declining margins.
•  High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates.
• Significant declines in customer demand and increasing business failures in either the industry or overall economy.
•  Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover imminent.

Opportunities

The nature of the industry or the company’s operations creates opportunities to engage in fraudulent financial reporting that can arise from the following:

•  Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate.
• Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions.
• Significant operations located or conducted across international borders in jurisdictions where differing business environments and cultures exist.
•  Use of business intermediaries for which there appears to be no clear business justification.
• Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for which there appears to be no clear business justification.

Attitudes/Rationalizations

 Non-financial management’s excessive participation in the selection of accounting policies or the determination of significant estimates.

•  Known history of violations of securities laws or other laws and regulations, or claims against the company, its senior management, or those charged with governance alleging fraud or violations of laws and regulations.
•  Management failing to remedy known significant deficiencies in internal control on a timely basis. 
•  Low morale among senior management.
• The owner-manager makes no distinction between personal and business transactions.
•  Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend.

These examples of fraud risk factors do not constitute the full list of fraud risk factors that could take place. Auditors may identify additional or different risk factors. In addition some risk factors may be of greater or lesser significance in companies of different size or with different ownership characteristics or circumstances.

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