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How Do Accounting Professionals Detect Fraud and Make Audit Decisions?

As stewards of fiscal responsibility, accountants play a critical role in detecting and responding to fraud through audits and other safeguards. Fraud causes immense financial harm, with organizations losing 5% of revenue to fraud each year for an estimated $4.7 trillion lost globally, according to the Association of Certified Fraud Examiners.

Avila University’s online Master of Business Administration (MBA) with a concentration in Accounting program prepares students for this function. The curriculum includes a Fraud Examination and Auditing course covering fraud assessment, prevention and response strategies. With the universal threat of fraud, auditors and financial professionals must remain vigilant. This article explores the critical question: What is an accountant’s role in detecting and responding to fraud?

What Is Accounting Fraud?

Accounting fraud, as defined by the Association of Certified Fraud Examiners, is a deliberate misrepresentation or deception orchestrated by an individual or entity with the potential to yield benefits for the wrongdoer or a third party. At its core, financial statement fraud is a prevalent form of accounting fraud characterized by manipulating financial statements to present a misleading image of a company’s financial health. This deceptive practice aims to portray the organization as more profitable than its actual standing, creating a façade that can have far-reaching consequences for investors, stakeholders and the financial markets.

Understanding the nuances of accounting fraud is imperative for accountants, as they play a pivotal role in detecting such misconduct and responding effectively to safeguard the integrity of financial reporting.

What Are Audits?

Accounting and auditing are inseparable components that work in tandem to ensure the accuracy and reliability of financial information. While accounting provides insights into a company’s financial health, profitability and performance, auditing verifies the correctness of the financial data presented by accountants. The work of an accountant is essentially validated and certified by an auditor.

The primary purpose of conducting an audit is to acquire an independent opinion regarding a company’s financial statements. Income statements, balance sheets and cash flow statements document the various financial activities of a company. Since these statements are internally generated, an independent auditor must verify their accuracy and reliability. Auditing is a safeguard, ensuring companies transparently represent their financial positions in accordance with established accounting standards.

There are three main types of audits: external, internal and Internal Revenue Service (IRS) audits. Internal auditors, employed by a company, scrutinize financial and business practices to ensure compliance with laws, enhance internal controls and identify process flaws. Operating independently, external auditors conduct comprehensive assessments of financial records and provide an objective opinion on the accuracy and completeness of a company’s financials.

The audit process involves several key steps, starting with the appointment of auditors and progressing through planning, understanding the client’s business, risk assessment, testing of controls, substantive audit procedures, an overall review of financial statements and issuance of the audit report.

What Is an Accountant’s Role in Detecting and Responding to Fraud?

Certified public accountants (CPAs) are crucial gatekeepers, as they identify fraud risks and detect material misstatements in financial statements. They may encounter challenges in fulfilling their gatekeeping responsibilities, such as a lack of substantive procedures tailored to fraud risks, insufficient testing of journal entries, failure to assess revenue recognition as a potential fraud risk and inadequate communication with audit committees about fraud risks. Audits do not protect against misstatements but provide reasonable assurance that fraud and errors will be detected.

As Kirsch CPA Group notes, one notable strategy employed by outside accountants is the execution of surprise audits, which delve into a company’s internal controls to prevent and detect fraud. By examining high-risk areas like inventory, receivables and sales, auditors aim to catch wrongdoers off guard. The element of surprise is crucial, as it prevents fraud perpetrators from covering their tracks, resulting in fewer financial losses and shorter scheme durations.

Kirsch CPA Group also notes that according to the 2022 Report to the Nations, organizations conducting surprise audits experienced a median loss of $75,000, compared to $150,000 for those without surprise audits. This showcases the effectiveness of this proactive approach.

What Types of Fraud Do Accounting Professionals Encounter?

Accounting professionals often encounter various types of fraud within organizations, exploiting gaps in business and financial processes. These fraudulent activities encompass accounting, insurance, identity, billing and tax fraud. To understand and address these issues, it is important to recognize the three elements required for fraud to occur: pressure, rationalization and opportunity.

Fraud manifests in two primary forms: cooking the books, where financial numbers are intentionally altered, and theft. With cooking the books, a critical aspect of fraud risk assessment involves examining incentives that may lead to manipulating financial statement numbers. Financial statement fraud takes various forms, such as overstating revenues by recording expected sales, concealing liabilities on balance sheets, inappropriately applying depreciation to inflate asset net worth and improperly disclosing structured finance deals and related-party transactions. This could include bonuses or promotions tied to profitability metrics.

On the other hand, theft occurs when employees resort to direct enrichment through misappropriation. The opportunity for theft arises from weak internal controls, emphasizing the importance of auditors who understand the accounting system and related controls. Addressing these nuanced challenges is crucial for accounting professionals acting as fraud detectors and responders.

Prepare to Execute Fraud Detection, Response and Audit Responsibilities

The Avila University online MBA in Accounting program offers a comprehensive foundation for individuals preparing to undertake the critical responsibilities of accounting. By exploring financial statement audits and the various types of fraud accounting professionals encounter, this program equips students with the skills needed to be vigilant and effective gatekeepers. As graduates enter the profession, the insights gained from the Avila program become invaluable, empowering them to fulfill their roles with expertise in detecting, responding to and auditing instances of fraud.

Learn more about Avila University’s online Master of Business Administration with a concentration in Accounting program.

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