Fraud and Responsibilities of the Auditor in this Regard: Notes | Auditing and Ethics for CA Intermediate PDF Download

 Page 1


 
 
LEARNING OUTCOMES 
  
FRAUD AND 
RESPONSIBILITIES OF THE 
AUDITOR IN THIS  
REGARD 
 
After studying this chapter, you will be able to: 
? Understand the types of errors and frauds. 
? Definition of fraud as given under the Standards on Auditing 
and its meaning. 
? Understand reasons behind management/ employees 
committing fraud/ error. 
? Analyse the duty of an auditor regarding detection of fraud and error.  
? Determine fraud risk factors and circumstances relating to 
possibility of fraud. 
? Understand responsibility of an auditor in case of withdrawal from the 
engagement if encounter any circumstances that bring into question 
his ability to continue due to fraud. 
CHAPTER 
5 
Page 2


 
 
LEARNING OUTCOMES 
  
FRAUD AND 
RESPONSIBILITIES OF THE 
AUDITOR IN THIS  
REGARD 
 
After studying this chapter, you will be able to: 
? Understand the types of errors and frauds. 
? Definition of fraud as given under the Standards on Auditing 
and its meaning. 
? Understand reasons behind management/ employees 
committing fraud/ error. 
? Analyse the duty of an auditor regarding detection of fraud and error.  
? Determine fraud risk factors and circumstances relating to 
possibility of fraud. 
? Understand responsibility of an auditor in case of withdrawal from the 
engagement if encounter any circumstances that bring into question 
his ability to continue due to fraud. 
CHAPTER 
5 
 
 
5.2 
 
AUDITING AND ASSURANCE 
 
1. MEANING OF FRAUD 
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud 
in an Audit of Financial Statements” de?nes the term ‘fraud’ as- 
“an 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”. 
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor     
is concerned with fraud that causes a material misstatement in the ?nancial 
statements. 
Two types of intentional misstatements are relevant to the auditor– 
? misstatements resulting from fraudulent ?nancial reporting and 
? misstatements resulting from misappropriation of assets. 
 
Page 3


 
 
LEARNING OUTCOMES 
  
FRAUD AND 
RESPONSIBILITIES OF THE 
AUDITOR IN THIS  
REGARD 
 
After studying this chapter, you will be able to: 
? Understand the types of errors and frauds. 
? Definition of fraud as given under the Standards on Auditing 
and its meaning. 
? Understand reasons behind management/ employees 
committing fraud/ error. 
? Analyse the duty of an auditor regarding detection of fraud and error.  
? Determine fraud risk factors and circumstances relating to 
possibility of fraud. 
? Understand responsibility of an auditor in case of withdrawal from the 
engagement if encounter any circumstances that bring into question 
his ability to continue due to fraud. 
CHAPTER 
5 
 
 
5.2 
 
AUDITING AND ASSURANCE 
 
1. MEANING OF FRAUD 
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud 
in an Audit of Financial Statements” de?nes the term ‘fraud’ as- 
“an 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”. 
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor     
is concerned with fraud that causes a material misstatement in the ?nancial 
statements. 
Two types of intentional misstatements are relevant to the auditor– 
? misstatements resulting from fraudulent ?nancial reporting and 
? misstatements resulting from misappropriation of assets. 
 
5.3 
 
FRAUD AND RESPONSIBILITIES OF THE AUDITOR 
IN THIS REGARD 
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, 
the auditor does not make legal determinations of whether fraud has actually 
occurred. 
2. CHARACTERISTICS OF FRAUD 
2.1 Fraud is Intentional 
Misstatements in the ?nancial statements can arise from either fraud or error. The 
distinguishing factor between fraud and error is whether the underlying action that 
results in the misstatement of the ?nancial statements is intentional or 
unintentional. 
2.2 Fraud is a broad legal concept 
The auditor is concerned with fraud that causes a material misstatement in the 
?nancial statements. 
Fraud, whether fraudulent ?nancial reporting or misappropriation of assets, 
involves incentive or pressure to commit fraud, a perceived opportunity to do 
so and some rationalization of the act. For example: 
? Incentive or pressure to commit fraudulent ?nancial reporting may exist when 
management is under pressure, from sources outside or inside the entity, to 
achieve an expected (and perhaps unrealistic) earnings target or ?nancial 
outcome. 
? A perceived opportunity to commit fraud may exist when an individual 
believes internal control can be overridden, for example, because the 
individual is in a position of trust or has knowledge of speci?c de?ciencies in 
internal control. 
Page 4


 
 
LEARNING OUTCOMES 
  
FRAUD AND 
RESPONSIBILITIES OF THE 
AUDITOR IN THIS  
REGARD 
 
After studying this chapter, you will be able to: 
? Understand the types of errors and frauds. 
? Definition of fraud as given under the Standards on Auditing 
and its meaning. 
? Understand reasons behind management/ employees 
committing fraud/ error. 
? Analyse the duty of an auditor regarding detection of fraud and error.  
? Determine fraud risk factors and circumstances relating to 
possibility of fraud. 
? Understand responsibility of an auditor in case of withdrawal from the 
engagement if encounter any circumstances that bring into question 
his ability to continue due to fraud. 
CHAPTER 
5 
 
 
5.2 
 
AUDITING AND ASSURANCE 
 
1. MEANING OF FRAUD 
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud 
in an Audit of Financial Statements” de?nes the term ‘fraud’ as- 
“an 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”. 
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor     
is concerned with fraud that causes a material misstatement in the ?nancial 
statements. 
Two types of intentional misstatements are relevant to the auditor– 
? misstatements resulting from fraudulent ?nancial reporting and 
? misstatements resulting from misappropriation of assets. 
 
5.3 
 
FRAUD AND RESPONSIBILITIES OF THE AUDITOR 
IN THIS REGARD 
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, 
the auditor does not make legal determinations of whether fraud has actually 
occurred. 
2. CHARACTERISTICS OF FRAUD 
2.1 Fraud is Intentional 
Misstatements in the ?nancial statements can arise from either fraud or error. The 
distinguishing factor between fraud and error is whether the underlying action that 
results in the misstatement of the ?nancial statements is intentional or 
unintentional. 
2.2 Fraud is a broad legal concept 
The auditor is concerned with fraud that causes a material misstatement in the 
?nancial statements. 
Fraud, whether fraudulent ?nancial reporting or misappropriation of assets, 
involves incentive or pressure to commit fraud, a perceived opportunity to do 
so and some rationalization of the act. For example: 
? Incentive or pressure to commit fraudulent ?nancial reporting may exist when 
management is under pressure, from sources outside or inside the entity, to 
achieve an expected (and perhaps unrealistic) earnings target or ?nancial 
outcome. 
? A perceived opportunity to commit fraud may exist when an individual 
believes internal control can be overridden, for example, because the 
individual is in a position of trust or has knowledge of speci?c de?ciencies in 
internal control. 
 
 
5.4 
 
AUDITING AND ASSURANCE 
? Individuals may be able to rationalize committing a fraudulent act. Some 
individuals possess an attitude, character or set of ethical values that allow 
them knowingly and intentionally to commit a dishonest act. However, even 
otherwise, honest individuals can commit fraud in an environment that 
imposes su?cient pressure on them. 
2.2.1 Fraudulent ?nancial reporting involves intentional misstatements 
including omissions of amounts or disclosures in ?nancial 
statements to deceive ?nancial statement users. 
Fraudulent ?nancial reporting may be accomplished by the following: 
Manipulation, falsi?cation (including forgery), or alteration of accounting records 
or supporting documentation from which the ?nancial statements are prepared. 
Manipulation of Accounts: Detection of manipulation of accounts with a view to 
presenting a false state of a?airs is a task requiring great tact and intelligence 
because generally management personnel in higher management cadre are 
associated with this type of fraud and this is perpetrated in methodical way. This 
type of fraud is generally committed: 
(a) to avoid incidence of income-tax or other taxes; 
(b) for declaring a dividend when there are insu?cient pro?ts; 
(c) to withhold declaration of dividend even when there is adequate pro?t (this   
is often done to manipulate the value of shares in stock market to make it 
possible for selected persons to acquire shares at a lower cost); and 
(d) for receiving higher remuneration where managerial remuneration is payable 
by reference to pro?ts. 
There are numerous ways of committing this type of fraud. Some of the methods 
are given below: 
(i) in?ating or suppressing purchases and expenses; 
Page 5


 
 
LEARNING OUTCOMES 
  
FRAUD AND 
RESPONSIBILITIES OF THE 
AUDITOR IN THIS  
REGARD 
 
After studying this chapter, you will be able to: 
? Understand the types of errors and frauds. 
? Definition of fraud as given under the Standards on Auditing 
and its meaning. 
? Understand reasons behind management/ employees 
committing fraud/ error. 
? Analyse the duty of an auditor regarding detection of fraud and error.  
? Determine fraud risk factors and circumstances relating to 
possibility of fraud. 
? Understand responsibility of an auditor in case of withdrawal from the 
engagement if encounter any circumstances that bring into question 
his ability to continue due to fraud. 
CHAPTER 
5 
 
 
5.2 
 
AUDITING AND ASSURANCE 
 
1. MEANING OF FRAUD 
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud 
in an Audit of Financial Statements” de?nes the term ‘fraud’ as- 
“an 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”. 
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor     
is concerned with fraud that causes a material misstatement in the ?nancial 
statements. 
Two types of intentional misstatements are relevant to the auditor– 
? misstatements resulting from fraudulent ?nancial reporting and 
? misstatements resulting from misappropriation of assets. 
 
5.3 
 
FRAUD AND RESPONSIBILITIES OF THE AUDITOR 
IN THIS REGARD 
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, 
the auditor does not make legal determinations of whether fraud has actually 
occurred. 
2. CHARACTERISTICS OF FRAUD 
2.1 Fraud is Intentional 
Misstatements in the ?nancial statements can arise from either fraud or error. The 
distinguishing factor between fraud and error is whether the underlying action that 
results in the misstatement of the ?nancial statements is intentional or 
unintentional. 
2.2 Fraud is a broad legal concept 
The auditor is concerned with fraud that causes a material misstatement in the 
?nancial statements. 
Fraud, whether fraudulent ?nancial reporting or misappropriation of assets, 
involves incentive or pressure to commit fraud, a perceived opportunity to do 
so and some rationalization of the act. For example: 
? Incentive or pressure to commit fraudulent ?nancial reporting may exist when 
management is under pressure, from sources outside or inside the entity, to 
achieve an expected (and perhaps unrealistic) earnings target or ?nancial 
outcome. 
? A perceived opportunity to commit fraud may exist when an individual 
believes internal control can be overridden, for example, because the 
individual is in a position of trust or has knowledge of speci?c de?ciencies in 
internal control. 
 
 
5.4 
 
AUDITING AND ASSURANCE 
? Individuals may be able to rationalize committing a fraudulent act. Some 
individuals possess an attitude, character or set of ethical values that allow 
them knowingly and intentionally to commit a dishonest act. However, even 
otherwise, honest individuals can commit fraud in an environment that 
imposes su?cient pressure on them. 
2.2.1 Fraudulent ?nancial reporting involves intentional misstatements 
including omissions of amounts or disclosures in ?nancial 
statements to deceive ?nancial statement users. 
Fraudulent ?nancial reporting may be accomplished by the following: 
Manipulation, falsi?cation (including forgery), or alteration of accounting records 
or supporting documentation from which the ?nancial statements are prepared. 
Manipulation of Accounts: Detection of manipulation of accounts with a view to 
presenting a false state of a?airs is a task requiring great tact and intelligence 
because generally management personnel in higher management cadre are 
associated with this type of fraud and this is perpetrated in methodical way. This 
type of fraud is generally committed: 
(a) to avoid incidence of income-tax or other taxes; 
(b) for declaring a dividend when there are insu?cient pro?ts; 
(c) to withhold declaration of dividend even when there is adequate pro?t (this   
is often done to manipulate the value of shares in stock market to make it 
possible for selected persons to acquire shares at a lower cost); and 
(d) for receiving higher remuneration where managerial remuneration is payable 
by reference to pro?ts. 
There are numerous ways of committing this type of fraud. Some of the methods 
are given below: 
(i) in?ating or suppressing purchases and expenses; 
 
 
5.5 
 
FRAUD AND RESPONSIBILITIES OF THE AUDITOR 
IN THIS REGARD 
(ii) in?ating or suppressing sales and other items of income, 
(iii) in?ating or de?ating the value of closing inventory; 
(iv) failing to adjust outstanding liabilities or prepaid expenses; and 
(v) charging items of capital expenditure to revenue or by capitalising revenue 
expenses. 
Misrepresentation in or intentional omission from, the ?nancial statements of 
events, transactions or other signi?cant information. 
Intentional misapplication of accounting principles relating to amounts, 
classi?cation, manner of presentation, or disclosure. 
Fraudulent ?nancial reporting often involves management override of 
controls that otherwise may appear to be operating e?ectively. Fraud can be 
committed by management overriding controls using such techniques as: 
? Recording ?ctitious journal entries, particularly close to the end of an 
accounting period, to manipulate operating results or achieve other objectives. 
? Inappropriately adjusting assumptions and changing judgments used to 
estimate account balances. 
? Omitting, advancing or delaying recognition in the ?nancial statements of 
events and transactions that have occurred during the reporting period. 
? Concealing, or not disclosing, facts that could a?ect the amounts recorded in 
the ?nancial statements. 
? Engaging in complex transactions that are structured to misrepresent the 
?nancial position or ?nancial performance of the entity. 
? Altering records and terms related to signi?cant and unusual transactions.