Real Frauds Found in Governments

Chapter 1Case 1: External Financial Reporting

Learning objectives

• Determine relevant fraud risks relating to management override in a fictitious government.
• Identify how management override of internal controls can lead to possible fraudulent financial reporting in a fictitious government.

Before we start

This case involves compliance with bond covenants on an interim and annual basis and reporting required information to rating agencies, trustees, and other oversight entities. Because noncompliance with bond covenants could have a material effect on a government’s financial statements, it may be considered a significant risk area. Additionally, the potential for management to override existing controls to manipulate financial and operational information to be in compliance with bond covenants might lead the auditor to identify this as a fraud risk area.

Management override is an area of concern for auditors because management may be able to easily access data and systems. In addition, employees may be reluctant to discuss management abuses during the auditor’s fraud inquiry procedures. Management override most often occurs in the following areas:

• Journal entries
• Estimates
• Business rationale for transactions
  • Bribes and kickbacks
  • Billing schemes

AU-C section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (AICPA Professional Standards), states the auditor should obtain a sufficient understanding of the entity and its environment, ...