AUDITING

Course No:505
Learning Objective

• Definition of errors & fraud

• Types of errors
• Detection & prevention of errors
• Detection & prevention of fraud
• Position of auditor in regard to errors & fraud
Types of errors
Errors

Errors of Compensating
Clerical Errors of
principle errors duplication
errors

Errors of
Errors of commission
omission
 Clerical errors:
These errors are committed in
posting, totaling and balancing.
Such errors may again be
subdivided into—
Errors of omission
Errors of commission
Errors of principle
Compensating errors
Errors of duplication
Technique of locating errors in
trial balance and correcting
• Check the totals of the trial balance.
• Comparing the names of the accounts in the
ledger with the names of the accounts as have
been recorded in the trial balance. It is possible
that balance of some accounts might not have
been transferred to the trial balance especially in
the case of the balance of cash book, purchases
and soles book, bills books etc
• Total the lists of debtors and creditors and
comparing them with the trial balance.
• If the books are maintained on the self-balancing
system; see that the total of different accounts
agrees with the total of these accounts with the
balance of accounts as recorded in the trial
balance.
Comparing the items of the trial balance with
the items of the trial balance of the previous
year to see if any teems has been omitted.
Whatever be the difference in the trial
balance, halve it and see if there s any items of
this value. This is done to avoid the putting of
the debit balance on the credit side of the trial
balance or vice versa.
It is possible that the totals of some
subsidiary books. e.g., Cash Book, purchases
Books. Sales books, etc, might not have been
transferred to trial balance. Re-check the totals
of these books.
Difference between Errors and Frauds

Subject Errors Frauds

Defination The term ‘Error’ refers to The term fraud refers to intentional
unintentional mistakes in financial misrepresentation of financial
information e.g. omission of an information by one or more
amount or disclosure, mistakes in
individuals among persons charged
gathering or processing financial
data, oversight or misinterpretation with governance (e.g. board of
of facts resulting in an incorrect directors and audit committee in the
accounting estimate or case of company),management,
unintentional misapplication of employees or third parties.
accounting principles.
Types There are four types of errors. There are three types of errors.
Nature It refers to unintentional Fraud refers to intentional act by one or
more individuals among
mistakes.
management those charged with
governance, employees or third
parties.
Character Errors are generally innocent. It may appear innocent at first sight,
ices are ultimately found to be due to
fraudulent manipulation .
Definition of Fraud:

Fraud refers to intentional act by one or more individuals among

management those charged with governance, employees or
third parties.
According to kamal gupta, “The term fraud refers to intentional
misrepresentation of financial information by one or more
individuals among persons charged with governance (e.g.
board of directors and audit committee in the case of
company), management, employees or third parties.”
Types of Fraud

Fraud

Embezzlement Misappropriati Fraudulent

of cash on of Goods manipulation
of Accounts
1.Embezzlement of cash:
There is a greater possibility of defalcation of money
in a big business house than in the case of a small
proprietary business where the proprietor has a
direct control over the receipts and payments of
cash. In a big business house, the system of
receipt and payment of cash should be such that
another clerk automatically checks the work of one
clerk. Such a system is known in auditing as
“Internal check” system, which will be dealt with in
detail later on. It is easier to misappropriate cash,
and, therefore, the auditor will do well to pay
particular attention towards cash transactions.
Cash may be misappropriated by:
Omitting to enter any cash which has been received, or
Entering less amount than what has been actually received,
or
Making fictitious entries on the payment side of the cash
book, or
Entering more amount on the payment side of the cash
book than what has been actually paid
Detection:
• In order to discover fraud under (A) and (B) above
the auditor should check the debit side of the cash
book with rough cash book, salesmen’s reports,
counterfoils of the receipt books, agents returns
and other original records while the fraud under (c)
and (D) can be discovered by reference to the
vouchers, wage sheets, salary book, invoice, etc..If
the accounts have been prepared on a uniform
basis, accounts of one year can be compared with
other years and if there is any discrepancy, the
cause may be enquired into.
Misappropriation of Goods:

1. . Fraud may be in respect of goods, i.e., misappropriation of

goods. These types of fraud are very difficult to detect
especially when the goods are less bulky and are of higher
value. Proper methods of keeping accounts in regard to
purchases and sales, stock taking, periodical checking of
stocks, comparing the percentage of gross profit to sales of
two periods, necessity for collusion will help to avoid
misappropriation of goods.
3.Fraudulent manipulation of Accounts
This types of fraud is more difficult to discover as it is usually committed
by directors or managers or other responsible officials with the object
of
A. Showing more profits than what actually they are (I) so that if they get
commission on profits, they may get more commission, or (II) their
service maybe retained by showing to the shareholders tat because of
their efficiency they have shown more profits and thus maintain the
confidence of the shareholders or (III) if they hold shares, they may
sell them at high price by declaring higher dividends, or (IV) to obtain
further credit by showing the financial position of the business better
than what actually it is, or (V) to attract more subscribers for the sale
of the shares of the company etc.
B. Showing less profits than what actually they are (i) in order to
purchase shares in the market at a lower price; or (ii) to reduce or
avoid the payment of income tax; or (iii) to give a wrong impression
about the success f the business to competitors etc.
Falsification of accounts may be
restored to-

• (a) by not providing any depreciation or providing less

depreciation or providing more depreciation. or
• (b) by under-valuation or over-calculation of assets and
liabilities; or
• (c) by showing fictitious sales or purchases or returns in
order to show more profits or less profits whatever the
case may b; or
• (d) by the utilization of secret reserves during a period
when the concern has made less or no profit, without
disclosing that fact to the shareholders, or
• (e) by sharing revenue expenditure to capital account or
vice versa or
• (f) by crediting the revenue account with the income
which will be received next year or not crediting the profit
and loss account with the income which has accrued but
which has not been received.
Detection: Such frauds are difficult to detect as
the people at the helm of affairs who are
presumed to be trustworthy, honest and
responsible commit them, and, therefore, no
suspicion falls on them. They are very cleverly
made and, as such, the auditor should be very
careful in detecting such fraud. He should carry
out the routine checking and vouching most
carefully and make searching, tactful and
intelligent inquiries.
 Duties or responsibility of the auditor for
Detection and prevention of Fraud and Error

The auditor has to obtain reasonable assurance

that financial information is properly stated in all
material respects. This impels that the auditor
seeks reasonable assurance that fraud or error
which may be material to the financial
information or the error is corrected. The auditor
should, therefore, plan his audit in such a manner
that he has a reasonable expectation of detesting
material misstatements in the financial
information resulting from fraud and error.
1. Responsibility for the detection of fraud and error: The
responsibility for the prevention and detection of fraud and error
rests with management through the implementation and
continued operation of an adequate system of internal control.
Such a system reduces but does not eliminate the possibility of
fraud and error.
The objective of an audit of financial information is to enable an
auditor to express an opinion on such financial information. In
forming his opinion, the auditor carries out procedures designed
to obtained evidence that will provide reasonable assurance that
the financial information is properly stated in al material respects.
Consequently, the auditor seeks reasonable assurance that fraud
or error which may be material to the financial information has no
occurred or that, if it has occurred, the affect of fraud is properly
reflected in the financial information or the error is corrected. The
auditor therefore, should plan his audit so that has a responsible
expectation of detecting material misstatements in the financial
information resulting from fraud and error.
2. Inherent limitations of an audit: Since the auditor
seeks to obtain persuasive rather than conclusive
evidence and relies on test checks, there is a
possibility that some material misstatement
resulting from fraud and error may not be detected
by him. However, the auditor should, in planning
and performing his examination, take into
consideration the risk of material misstatement of
the financial information caused by fraud or error.
3.Conditions increasing the risk of Fraud and
Error: In addition to weaknesses in the design of
the internal control system anal noncompliance
with identified central precedence conditions or
events which increase the risk of fraud or error
inculcate:-
1.Questions with respect to the integrity or
competence of management,
2.Unusual transactions,
3.Problems on obtaining sufficient
appropriate evidence.
4.Procedures when there is an indication that fraud or
Error may exist: It circumstances indicate the possible
existence of fraud or error, the auditor should consider the
potential effect on the financial information. It the auditor
believes the suspected fraud or error could have a material effect
on the financial information, he should perform such modified or
additional procedures as he determines to be appropriate. The
extent of such modifications or additional procedures depends on
the auditor’s judgment as to the type of fraud or error that could
occur, the relative risk of their occurrence, the likelihood that a
particular type of fraud or error could have a material effect on
the financial information.
Perfuming modified or additional procedures will normally enable
the auditor to confirm or dispel a suspicion of fraud or error
where confirmed, he should satisfy himself that the effect of fraud
is properly reflected in the financial information or the error is
corrected.
5. Role of Internal control system: The
implementation and continued operation of an adequate
internal control system reduces the probability o
occurrence of fraud or error However, It should be
recognized that any system of internal control may be in
effective against certain types of frauds.
6. Other reporting Responsibilities: The auditor should
communicate his findings to management on a timely
basis if, he believes fraud may exist, even if the potentia
effect on the financial information would be immaterial; o
fraud or significant error is actually found to exist. In the
latter circumstance, he should also consider his reporting
responsibilities to regulatory authorities.
1. a) what is auditing? Discuss its basic objects. 4
b) Define Audit Programme. What factors should be
considered in preparing Audit Programme? Discuss its 6
advantages.
2.a) Distinguished among continuous audit, periodical or 3
annual audit and Interim audit.

b) What is continuous audit and to what class of business is 7

it especially applicable? State briefly the advantages of and
the objections to an audit of this nature.

2. a) Distinguish between errors & frauds/types of errors & 3

frauds
b) As an auditor how you can detect & prevent errors & frauds. 3
c) Discuss the position of the auditor regarding errors &
frauds. 4
Thank
You