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CH 12 Fraud and Error

This document discusses fraud and error in auditing. It defines fraud and distinguishes it from error. There are two main types of intentional misstatements: fraudulent financial reporting and misappropriation of assets. The fraud triangle involving incentives, opportunities, and attitudes that can lead to fraud is also described. Risk factors for both types of fraud are provided as examples. The document outlines auditor responsibilities in assessing risks of material misstatement due to fraud or error and responding appropriately, including communication requirements and documentation.

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Joyce Anne Garduque
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170 views28 pages

CH 12 Fraud and Error

This document discusses fraud and error in auditing. It defines fraud and distinguishes it from error. There are two main types of intentional misstatements: fraudulent financial reporting and misappropriation of assets. The fraud triangle involving incentives, opportunities, and attitudes that can lead to fraud is also described. Risk factors for both types of fraud are provided as examples. The document outlines auditor responsibilities in assessing risks of material misstatement due to fraud or error and responding appropriately, including communication requirements and documentation.

Uploaded by

Joyce Anne Garduque
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER 12

FRAUD AND
ERROR
CHARACTERISTICS OF
FRAUD
• PSA 240 “The Auditor’s Responsibility to consider fraud
in an Audit of Financial Statement”
• FRAUD VS ERROR
• Types of intentional misstatements:
1. Misstatements resulting to fraudulent financial
reporting
2. Misstatement resulting from misappropriation of
assets
• Fraud triangle
FRAUDELENT FINANCIAL
REPORTING
• Involves the intentional misstatements including omissions of
amounts or disclosure in financial statements to deceive financial
statement users.
Fraudulent financial reporting may be accomplished by the following:
-manipulation, falsification, or alteration of accounting records or
supporting documentation
-misrepresentation in or intentional omission, from the financial
statement of events
-intentional misapplication of accounting principles relating to amounts,
classification, manner of presentation and disclosure
FRAUDELENT FINANCIAL
REPORTING
• Fraudulent financial reporting often involves management override of
controls that otherwise may appear to be operating effectively
MISSAPPROPRIATION OF
ASSETS
• Misappropriation of assets involves the theft of an entity’s assets and is often
perpetrated by employees in relatively small and immaterial amounts.
However, it can also involve management
Misappropriation of assets Can be accompanied in a. variety of ways including:
1. Embezzling receipts
2. Stealing physical assets or intellectual property
RESPONSIBILITIES FOR THE
PREVENTION AND DETECTION OF
FRAUD
primary responsibility for the prevention and
detection of fraud tests with both those
charged with governance of the entity and
management
RESPONSIBILITIES OF THE AUDITOR
in accordance with PSA an auditor is
responsible for obtaining reasonable assurance
that the financial statements taken as whole are
free from material misstatement whether caused
by fraud or error
RISK ASSESSMENT
• the auditor should assess the risk that fraud and error may cause
the financial statements to contain material misstatements and
should inquire of management as to any fraud or significant
error which has been discovered
RISK ASSESSMENT
In addition to weaknesses in the design of the accounting and
internal control systems and noncompliance with identified
internal controls conditions or events which increase the risk of
fraud and error include:
1. Questions with respect to the integrity or competence of
management.
2. Unusual pressures within or on an entity.
3. Unusual transactions.
4. Problems in obtaining sufficient appropriate audit evidence.
Detection
The auditor should design audit procedures to obtain reasonable
assurance that misstatements arising from fraud and error that are
material to the financial statements taken as a whole are detected.

The likelihood of detecting errors ordinarily is higher than that of


detecting fraud
Inherent Limitations of an Audit
• Audit is subject to the unavoidable risk that some material
misstatements of the financial statements will not be detected,
even though the audit is properly planned and performed in
accordance with PSA
• The auditor should plan and perform the audit with an
attitude of professional skepticism
RISK FACTORS
• A.K.A Fraud Triangle
OPPORTUNITY
• Weak internal control
INCENTIVES/PRESSURE
• Unrealistic objectives
ATTITUDE AND
RATIONALIZATION
• Values and beliefs
EXAMPLE OF RISK FACTORS
Risk Factors Relating to Misstatement Resulting to Fraudulent Financial
Reporting
A. Incentives
1. Threatened financial stability or profitability brought about by
economic. industry or entity operating conditions
2. Excessive pressure from the management to meet requirements or
expectations of third parties
3. Threatened personal financial situation of management or those
charged with governance relative to the entity’s financial performance
EXAMPLE OF RISK FACTORS
Risk Factors Relating to Misstatement Resulting to Fraudulent Financial
Reporting
B. Opportunities
1. Nature of the industry or the entity’s operations provides opportunities
to engage in fraudulent financial reporting
2. Ineffective monitoring of management
3. Complex and unstable organizational structure
4. Deficiency in internal control of components
EXAMPLE OF RISK FACTORS
Risk Factors Relating to Misstatement Resulting to Fraudulent Financial
Reporting
C. Attitudes and Rationalization
1. Communication. implementation. support. or enforcement of the
entity's values or ethical standards by management, or the
communication of inappropriate values or ethical standards. that are not
effective.
2. Excessive interest by management in maintaining or increasing the
entity's stock price or earnings trend.
EXAMPLE OF RISK FACTORS
Risk Factors Relating to Misstatement Resulting to Fraudulent Financial
Reporting
C. Attitudes and Rationalization
3. The practice by management of committing to analyst creditors. and
other third parties to achieve aggressive or unrealistic forecasts.
4. Management failing to correct known material weaknesses in internal
control on a timely basis.
5. An. interest by management in employing inappropriate means to
minimize reported earnings for tax-motivated reasons.
EXAMPLE OF RISK FACTORS
Risk Factors Arising from Misstatements Resulting to Misappropriation
of Assets
A. Incentives / Pressures
1. Personal financial obligations may create pressure on management
or employees with access to cash or other assets susceptible to theft to
misappropriate those assets.
2. Adverse relationships between the entity and employees with access
to cash or other assets susceptible to theft may motivate those
employees to misappropriate those assets.
EXAMPLE OF RISK FACTORS
Risk Factors Arising from Misstatements Resulting to Misappropriation
of Assets
Opportunities
1. Certain characteristics or circumstances may increase the
susceptibility of assets to misappropriation.
2. Inadequate internal control over assets may increase the susceptibility
of misappropriation of those assets.
EXAMPLE OF RISK FACTORS
Risk Factors Arising from Misstatements Resulting to Misappropriation
of Assets
C. Attitudes / Rationalizations
1. Disregard for internal control over misappropriation of assets by
overriding existing controls or by failing to correct known internal
control deficiencies.
2. Behavior indicating displeasure or dissatisfaction with the entity or its
treatment of the employee.
3. Tolerance of petty theft.
PROCEDURES WHEN
ERRORS OR
IRREGULARITIES ARE
SUSPECTED
When an auditor detects factors that increase audit risk at the financial
statement level he or she should respond to such elevated risk by altering
the
- Engagement staffing.
- Extent of staff supervision,
- Degree of professional skepticism applied, and/or
- Overall strategy for the expected conduct and scope of the
engagement.
PROCEDURES WHEN
ERRORS OR
IRREGULARITIES ARE
SUSPECTED
If the auditor believes the indicated fraud or error could have a material
effect on the financial statements, the auditor should perform appropriate
modified or additional procedures

Unless circumstances clearly indicate otherwise, the auditor cannot


assume that an instance of fraud or error is an isolated occurrence. If
necessary, the auditor adjusts the nature, timing and extent of substantive
procedures
REPORTING OF FRAUD AND
ERROR
Communication to Management and With Those Charged with
Governance
To Management:
The auditor should communicate factual findings to management
as soon as practicable if
1. the auditor suspects fraud may exist, even if the potential effect
on the financial statements would be immaterial; or
2. fraud or significant error is actually found to exist
DOCUMENTATION
The auditor's documentation of the understanding of the entity and its
Environment and the assessment of the risks of material misstatement
required by p5A 315 shall include:
1. The significant decisions reached during the discussion among the
engagement team regarding the susceptibility of the entity's financial
statements to material misstatement due to fraud; and
2. The identified and assessed risks of material misstatement due to
fraud at the financial statement level and at the assertion level.
WITHDRAWAL FROM THE
ENGAGEMENT

a. Determine professional and legal responsibility


b. Consider whether withdrawal is appropriate and legally permitted
c. If auditor withdraws:
(1) Discuss with the appropriate level of management and those charged
with governance the auditor’s withdrawal and reasons for withdrawal
(2) Determine whether there is a professional or legal requirement to
report
 
END

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