Auditor’s Responsibility

What is the auditor’s responsibility?

- to design the audit to provide reasonable assurance of detecting material
misstatements in the financial statements. These statements may emanate from

1. Error
2. Fraud, and
3. Noncompliance with Laws and Regulations

Error
- The term “error” refers to unintentional misstatements in the financial statements,
including the omission of an amount or a disclosure such as:
 Mathematical or clerical mistakes in the underlying records and accounting data
 An incorrect accounting estimate arising from oversight or misinterpretation of facts
 Mistake in the application of accounting policies

Fraud
- refers to intentional act by one or more individuals among management, those charged
with governance, employees, or third parties, involving the use of deception to obtain an
unjust or illegal advantage.
- the auditor is primarily concerned with fraudulent acts that cause a material
misstatement in the financial statements

Types of Fraud
1. Fraudulent financial reporting
- involves unintentional misstatements or omissions of amounts or disclosures in the
financial statements to deceive financial statement users.
- also known as management fraud, because it usually involves members of management or
those charged with governance. This may involve
 Manipulations, falsification or alteration of records or documents
 Misrepresentation in or intentional omission of the effects of transactions from records
or documents
 Recording of transactions without substance
 Intentional misapplication of accounting policies

2. Misappropriation of assets or employee fraud

- involves the theft of an entity’s assets committed by the entity’s employees.
- This type of fraud is often accompanied by false or misleading records or documents in
order to conceal the fact that the assets are missing. This may include
 Embezzling of receipts
 Stealing entity’s assets such as cash, marketable securities, and inventory
 Lapping of accounts receivable

Fraud involves motivation to commit and a perceived opportunity to do so.

Example Scenarios
1. An employee might be motivated to steal company’s assets because this employee lives
beyond his means.
2. A member of management may be forced to manipulate the financial statements in order
to meet an overly optimistic projection.

Perceived opportunity
- may exist when there is no proper segregation of duties among employees or when
management believes that internal control can be circumvented

The auditor’s responsibility for the detection of fraud and error is essentially the same.

Responsibility of Management and Those Charged with Governance

- responsibility for the prevention and detection of fraud and error rests with both
management and those charged with the governance of the entity. In this regard, PSA 240
requires

 Management to establish a control environment and to implement internal control

policies and procedures designed to ensure, among others, the detection and
prevention of fraud and error
 Individuals charged with governance of an entity to ensure the integrity of an entity’s
accounting and financial reporting systems and that appropriate controls are in place

Auditor’s Responsibility (for Fraud and Error) according to Different Phases

 Planning Phase
1. Auditor should make inquiries of management about the possibility of missatement due
to fraud and error.
Such inquiries may include:
 Management’s assessment of risks due to fraud
 Controls established to address the risks
 Any material error or fraud that has affected the entity or suspected fraud that the
entity is investigating

2. The auditor should assess the risk that fraud or error may cause the financial statements
to contain material misstatements.

 Testing Phase

3. During the course of the audit, the auditor may encounter circumstances that may
indicate the possibility of fraud or error.
4. After identifying material misstatement in the financial statements, the auditor should
consider whether such misstatement resulted from a fraud or an error.

 Completion Phase
5. The auditor should obtain a written representation from the client’s management that:
- it acknowledges its responsibility for the implementation and operations of accounting
and internal control systems that are designed to prevent and detect fraud and error
 - It believes that effects of those uncorrected financial statement misstatements
aggregated by the auditor during the audit are immaterial, both individually and in the
aggregate to the financial statements
- it has disclosed to the auditor all significant facts relating to any frauds or suspected
frauds known to management
- it has disclosed to te auditor results of its assessment of the risk that the financial
statements may be materially misstated as a result of fraud

 Consider the Effects on the Auditor’s Report

6. When the auditor believes that material error or fraud exists, he should request the
management to revise the financial statements. Otherwise, the auditor will express a
qualified or adverse opinion
7. If the auditor is unable to evaluate the effect of fraud on the financial statements
because of a limitation on the scope of the auditor’s examination, the auditor should either
qualify or disclaim his opinion on the financial statements

Noncompliance with Laws and Regulations

What is Noncompliance?
- refers to acts of omission or commission by the entity being audited, either intentional or
unintentional which are contrary to the prevailing laws or regulations. Such acts include
transactions entered into by, or in the name of, the entity or on its behalf by its
management or employees.
Common examples include:
 Tax evasion
 Violation of environmental protection laws
 Inside trading of securities

Responsibility of Management and Those Charged with Governance

- It is management’s responsibility to ensure that the entity’s operations are conducted in
accordance with laws and regulations. The responsibility for the prevention and detection of
noncompliance rests with management.

Auditor’s Responsibility (for Noncompliance with Laws and Regulations) according to

Different Phases

 Planning Phase
1. The auditor should obtain a general understanding of the legal and regulatory framework
applicable to the entity and the industry and how the entity is complying with that
framework
2. The auditor should design procedures to help identify instances of noncompliance with
those laws and regulations where noncompliance should be considered when preparing
financial statements
3. The auditor should also design audit procedures to obtain sufficient appropriate audit
evidence about compliance with those laws and regulations generally recognized by the
auditor to have an effect on the determination of material amounts and disclosures in
financial statements

 Testing Phase
4. When the auditor becomes aware of information concerning a possible instance of
noncompliance, the auditor should obtain an understanding of the nature of the act and the
circumstances in which it has occurred, and sufficient other information to evaluate the
possible effect on the financial statements.
5. When the auditor believes there may be noncompliance, the auditor should document
the findings, discuss them with management, and consider the implication and other aspects
of the audit

 Completion Phase
6. The auditor should obtain a written representations that management has disclosed to
the auditor all known actual or possible noncompliance with laws and regulations
7. When the auditor believes that there is a noncompliance, he should request the
management to revise the financial statements. Otherwise, a qualified or adverse opinion
will be issued.
8. If a scope limitation has precluded the auditor from obtaining sufficient appropriate
evidence to evaluate the effect of noncompliance with laws and regulatons, the auditor
should express a qualified opinion or a disclaimer of opinion.