Balancing Trust and Skepticism

The Unique Alternative to the Big Four®
Balancing Trust and Skepticism: How a Trusting Culture
Could Provide an Opportunity for Fraud to Occur
March 4, 2014
The Unique Alternative to the Big Four®
Skepticism: Do You Have The Proper Mindset?
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Polling Question #1
Many believe that skepticism is important for what we do. Do you believe that
management is dishonest unless proven otherwise?




Yes
No
I am neutral and don’t make any assumptions regarding management
Unsure/don’t know
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Knowledge Hierarchy
Wisdom
Knowledge
Information
Data
Chaos
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Theory
• An individual’s integrity does not generalize across
situations and is not internalized as a personal
value.
• An individual’s behavior is influenced more by the
situation:
•
•
•
•
•
Opportunity to be dishonest
Probable gain from cheating
Likelihood of getting caught
Severity of the punishment
Perceived need for more money
• Usually most individuals:
•
•
10
Unethical
Situational
80
10
Ethical
Believe in honesty
Can be tempted by convenient opportunities and
intense situational pressures
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Culture
Is it really trust or are people just disconnected?
 Unhappy
 Poorly compensated
 Poorly treated by
 Distracted by outside issues
 Believe leadership is dishonest
 Afraid to lose job (fear)
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Skepticism- IIA Definition
 “The state of mind in which internal auditors take nothing for granted; they
continuously question what they hear and see and critically assess audit
evidence.”
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Skepticism-CAQ Definition
 “Is fundamental to an independent auditor’s objectivity and includes a
questioning mind and an objective assessment of audit evidence. It requires
an emphasis on the importance of maintaining the proper state of mind
throughout the audit. The independent auditor uses his or her knowledge, skill,
and ability to diligently perform, in good faith and with integrity, the gathering
and objective evaluation of audit evidence. Given that evidence is gathered and
evaluated throughout the audit, professional skepticism is exercised throughout
the entire audit process.”
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SAS No. 99: Skepticism
 An auditor is instructed to conduct an audit “with a questioning mind that
recognizes the possibility that a material misstatement due to fraud could be
present, regardless of any past experience with the entity and regardless of the
auditor’s belief about management’s honesty and integrity.”
“Trust is a professional hazard…..verify, verify, verify!”
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Persuasive Audit Evidence
 This enables the internal auditor to formulate well-founded conclusions and
advice confidently. To be persuasive, the evidence must be relevant, reliable,
and sufficient.
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Relevant, Reliable, & Sufficient
 Is the evidence pertinent to the audit objective? Does it logically support the
auditor's conclusion or advice?
 Did the evidence come from a credible source? Did the auditor directly obtain the
evidence?
 Has the auditor obtained enough evidence? Do different, but related, pieces of
evidence corroborate each other?
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Polling Question #2
Do you believe that on-going training can expand one’s knowledge base, which in
turn may make you more cognizant of irregularities when encountered and thus
increase your level of skepticism?




Yes
Maybe
No
Unsure/don’t know
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Skepticism – Better Fraud Detection
1.
2.
3.
4.
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Increased information
search
Increased inconsistency or
contradiction detection
Increased alternative
generation
Expanded scrutiny
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Why Do We Fail?
 Fooled by the Tone from the Top
 Insufficient understanding of the business
 Failed to obtain sufficient competent evidence to corroborate management
representations and explanations
 Inadequate risk assessments
 Truncated or improperly designed procedures
 Other
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Freud in Fraud – The Mind Behind the Crime
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How to Think About Preventing What Can Go Wrong
 Professional skepticism - an attitude that includes a questioning mind and a
critical assessment of audit evidence
 More complete expression – a critical self assessment of one’s own beliefs
and belief-based risk assessments
 The professional skeptic will challenge his/her own beliefs and seek to ensure
that he/she will be able to demonstrate to others why and how such beliefs and
belief-based risk assessments are sufficiently well-justified
 Self-criticize each significant judgment; play the role of the independent
reviewer or inspector
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How to Think About Preventing What Can Go Wrong Cont’d
 Narrow focus on sufficiency and appropriateness of evidence instead of
sufficiently well-justified beliefs and belief-based risk assessments
 Truncating risk assessment procedures due, for example, to time pressure
 Placing undue weight on prior risk assessments when revising beliefs and
risk assessments in response to additional evidence
 Discounting evidence that is not consistent with prior expectations
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How to Think About Preventing What Can Go Wrong (cont’d)
 Understanding the key sources of evidence and identify and assess audit risks
from multiple perspectives, using multiple sources of evidence
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Multiple Perspectives
•
•
•
•
•
Suppliers
Customers
Competitors
Alliance partners
Regulators
•
•
•
•
•
•
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•
•
•
Manual processes
Automated
processes
Internal controls,
including ICFR
General Ledger
Journals
Financial Statements
MD&A
Other disclosures
Other filings
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Polling Question #3
Who is primarily responsible for deterring financial reporting fraud?

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





Management
Board
Internal audit
External audit
All of the above
None of the above
Board and management
Some other combination
Unsure/don’t know
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Survey of the Supply Chain
Internal Audit
Company
Management
Supply
Chain
Audit
Committee
External Audit
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3 Lines of Defense
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Who Has the Primary Role in Deterring Financial Reporting
Fraud?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
Source: “Closing the Expectation Gap in Deterring and
Detecting Financial Statement Fraud: A Roundtable Summary “
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
BoD/AC
Int Audit
Ext Audit
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Who Has the Primary Role in Deterring Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
87%
78%
90%
90%
90%
BoD/AC
10%
20%
6%
8%
6%
Int Audit
2%
2%
4%
2%
2%
Ext Audit
1%
1%
0%
0%
2%
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Who Has the Primary Role in Detecting Financial Reporting
Fraud (cont’d)?
All
CAQ
FEI
IIA
NACD
Execs
52%
56%
52%
51%
46%
BoD/AC
6%
9%
6%
4%
2%
Int Audit
31%
32%
33%
28%
29%
Ext Audit
12%
4%
9%
18%
23%
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How Reasonable is it for us to Deter/Detect Financial
Reporting Fraud?
CAQ
Ext Audit
FEI
IIA
NACD
2.3 / 2.9
Financial
Execs
4.2 / 3.7
Int Audit
3.0 / 3.3
BoD
3.0 / 2.3
Scale:
5 = Very reasonable
1 = Not reasonable at all
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Level of Confidence in Identifying a Potential Material
Misstatement Due to Fraud?
Percent Confident or Highly Confident
All
CAQ
FEI
IIA
NACD
Execs
84%
85%
86%
76%
96%
BoD/AC
48%
46%
54%
36%
75%
Int Audit
86%
81%
88%
86%
92%
Ext Audit
81%
82%
73%
82%
90%
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In Preparing or Reviewing Financial Statements, One Should
Exercise Skepticism?
Percent Agree or Strongly Agree
All
CAQ
FEI
IIA
NACD
86%
91%
82%
82%
90%
Percent Disagree or Strongly Disagree
All
CAQ
FEI
IIA
NACD
13%
8%
15%
16%
10%
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Level of Confidence that Each Party Exercises a Sufficient
Level of Skepticism?
Percent Confident or Highly Confident
All
CAQ
FEI
IIA
NACD
Execs
82%
73%
89%
76%
96%
BoD/AC
76%
74%
80%
66%
94%
Int Audit
90%
82%
91%
94%
98%
Ext Audit
94%
98%
90%
93%
98%
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Trust verses Skepticism?
(in organizations associated with)
All
CAQ
FEI
IIA
NACD
More trust than
skepticism
31%
22%
31%
42%
21%
More skepticism
than trust
6%
5%
9%
7%
0%
Appropriate
balance
60%
70%
58%
46%
79%
“Not enough trust or skepticism”
“The question should be … about how much the grey areas are bent to
achieve the desired end results.”
“There is not enough trust and not enough skepticism.”
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Effectiveness of Methods to Deter/Detect Financial Reporting
Fraud?
All
CAQ
FEI
IIA
NACD
Communicating
code of conduct
and corporate
values
4.5
4.1
4.5
4.7
4.6
Ethics training
4.3
4.1
4.1
4.5
4.3
Employee hotlines
4.3
4.3
4.1
4.6
4.4
Employee
surveys*
3.9
3.9
3.7
4.1
4.1
*providing useful information
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Scale:
5 = Strongly Agree
3 = Neutral
1 = Strongly Disagree
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Survey Demographics
 Survey was open from 10/3 to 11/14/12
 Total responses – 432, with people identifying themselves as most affiliated with:
 32% IIA, 31% FEI, 26% CAQ, 12% NACD
 Organization (or primary clientele):




48% publicly traded
31% privately held
10% non-profit
7% public sector
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Polling Question #4
Of the following, who do you believe is responsible for mitigating the risk of fraud?






External Audit
Internal Audit
Board
Senior Management
Shared responsibility
Unsure/don’t know
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Shared Responsibility to the Investing Public for Mitigating the Risk of Financial Reporting Fraud
Principal Anti-Fraud Role
Skepticism
•
•
•
•
•
•
Internal
Audit
Objective
assurance
External
Audit
External
independent
attestation
Management
Primary responsibility for
financial reporting process
•
•
•
•
•
•
Oversight of tone at the top, financial
reporting, internal & external auditor
Solid knowledge of industry/business
Understanding of fraud risks
Independence and objectivity
Ability to challenge management, the
board, and the audit committee
Assess fraud risks and monitor controls
Independence and objectivity
Ability to challenge management, the
board, and the audit committee
Assess fraud risks as part of audit
planning and execution
Effective Communication
Board
and Audit
Committee
Governance and
oversight
Strong tone at the top
Maintenance of effective internal
controls
Robust fraud risk management
program
Financial Reporting Supply Chain
Source: Center for Audit Quality
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Summary of the Key Messages

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Auditing requires professional judgment and is a decision making journey.
Society demands good judgment and decision-making from us.
Understand that your own beliefs are fallible.
Be self-critical of your own judgments.
Don’t be afraid to ask for second opinions from others, including your
supervisors.
 Expect to be held accountable for your judgments and be prepared to.
demonstrate to others why and how your beliefs are sufficiently well-justified.
 Take your time and don’t be forced into rushing your work.
 Always do your homework!
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Are You a STAR™?
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Questions?
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The Unique Alternative to the Big Four®
For more information, contact:
Jonathan Marks, CPA, CFF, CITP, CGMA, CFE
Partner & National Leader-Fraud, Ethics, & Anti-Corruption Services
Direct 212.572.5576
Mobile 267.261.4947 (Preferred)
[email protected]
Twitter@jtmarkscpa
Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate
and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any
other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or
any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member
of Crowe Horwath International. This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidance
specific to your organization from qualified advisers in your jurisdiction. © 2014 Crowe Horwath LLP
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