SAS 82 outlines risk factors associated with management fraud

Note: Given the economic impact of such "wild card" events as Enron and Sept. 11, it is critical that CPAs stay focused on the basics and carefully evaluate risks. This applies whether you are a CPA performing the audit, or whether you are working for the organization or company preparing the financial statements.

The following is an excerpt from "The Rise and Fall of the Enron Empire," an article by Bill Thomas, CPA, Ph.D., professor of accounting at Baylor University. The article recently appeared in Today's CPA, a publication of the Texas Society of CPAs.

By Bill Thomas, CPA, Ph.D.
Professor of accounting, Baylor University

Hindsight is so clear that it sometimes belies the complexity of the problem. Although fraud has not yet been proven to be a factor in Enron's misstatements, some of the classic risk factors associated with management fraud that are outlined in SAS No. 82 are evident in the Enron case. Those include management characteristics, industry conditions, and operating characteristics of the company.

Although written five years ago, the list of characteristics almost looks as if it were excerpted from Enron:

unduly aggressive earnings targets and management bonus compensation based on those targets;
excessive interest by management in maintaining stock price or earnings trend through the use of unusually aggressive accounting practices;
management setting unduly aggressive financial targets and expectations for operating personnel;
inability to generate sufficient cash flow from operations while reporting earnings and earnings growth;
assets, liabilities, revenues, or expenses based on significant estimates that involve unusually subjective judgments such as ... realizability of financial instruments; and
significant related-party transactions.

These factors are common threads in the tapestry that is descriptive of the environment leading to fraud. They were incorporated into SAS No. 82 on the basis of research into fraud cases of the 1970s and 1980s, in the hope that auditors would learn from the past.

Note from the MACPA

SAS 82 requires the auditor on every engagement to assess and document the risk of material misstatements for two major types of fraud — fraudulent financial reporting and misappropriation of assets. Based on the assessment of risk, SAS 82 requires the auditor to develop a specific response. The auditor should document in the working papers evidence of the performance of the assessment of the risk of material misstatement due to fraud, including how fraud risk factors were considered. Whenever the auditor has determined that there is evidence that fraud may exist, the matter should be brought to the attention of the appropriate level of management.

Because of the complexity the issues involved, the auditor may wish to consult with legal counsel before discussing these matters outside the client.

This summary is not intended to be a comprehensive analysis of this important standard. The AICPA has published a nonauthoritative practice aid, "Considering Fraud in a Financial Statement Audit: Practical Guidance for Applying SAS No. 82."

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