The Center for Audit Quality is encouraging audit firms to follow a common format for testing journal entries and other journal adjustments to make it easier for auditors to spot potential fraud.

The CAQ developed a practice aid with the help of auditors from its various member firms for testing journal entries based on the requirements of AU Section 316, “Consideration of Fraud in a Financial Statement Audit.” That’s the standard audit firms are required to follow when auditing financial statements for public companies.

Studies have supported the notion that fraudulent financial reporting often involves bogus journal entries, especially post-closing adjustments and other types of nonstandard journal entries. AU Section 316 requires auditors to assume the risk of management override is always present and therefore test journal entries and other adjustments to look for signs of abuse. The Public Company Accounting Oversight Board said in a 2007 report that auditors have some issues to address with respect to testing journal entries to ferret out fraud.

“Every firm and every company makes journal entries in different ways,” said Cindy Fornelli, executive director of the CAQ. “There is no uniform way. That makes the auditor’s job harder because there’s no uniform way to look for fraud.”

The practice alert is part of CAQ’s efforts to help audit firms develop more effective methods to prevent and detect fraud, Fornelli said. On a longer term basis, however, the CAQ will be working with the PCAOB in helping to develop a national center for fraud prevention and detection best practices. The Treasury Advisory Committee on the Auditing Profession suggested the PCAOB develop such a center to help advance the practice of deterring and identifying fraudulent financial reporting.

The practice aid provides auditors with examples of some of the practices currently in use by some firms, which the CAQ said may be helpful for the design and performance of audit procedures to meet the requirements of AU Section 316. It explores obtaining an understanding of internal controls over journal entries, selecting journal entries for testing, evaluating selected journal entries and documenting the results of journal entry testing.

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