19. Fraud

Question 1

What is the difference between error and fraud?

Answer 1

Error is an unintentional misstatement in the financial statement.
Fraud is an intentional act by one or more individuals involving the use of deception to obtain an unjust or illegal advantage.

Question 2

Explain types of fraud?

Answer 2

1. Misappropriation of assets: It involves theft of entity’s assets and is committed by employees. It includes embezzling receipts, stealing physical assets or intellectual property, causing an entity to pay for good or services not received, using assets for personal use.
2. Fraudulent financial reporting: It involves intentional misstatements in the financial statements to deceive the users. It includes recording fictitious journal entries, inappropriately changing assumptions and judgements, altering the records.

Question 3

What are the responsibilities of management regarding fraud?

Answer 3

The primary responsibility is prevention and detection of fraud which rests with the management and TCWG.
Management should establish systems and controls to prevent and detect the fraud. TCWG should monitor the systems and controls and should also consider the possibility of management override of controls.

Question 4

What is the responsibility of auditor regarding fraud?

Answer 4

Auditor’s primary responsibility is to express and opinion on financial statements. Auditor is not primarily responsible to prevent or detect frauds as it may involve sophisticated techniques and collusion.
He is responsible to:
perform procedures to identify risk of material misstatement due to fraud
maintain professional skepticism throughout the audit
perform procedures on identification of risk of fraud.

Question 5

What should the auditor’s course of action if there is fraud?

Answer 5

1. Auditor shall communicate fraud to appropriate level of management.
2. Communicate fraud with TCWG if amount in significant or management is involved.
3. Communicate to the regulatory authority only if it is required by law.
4. If there is a doubt on integrity of management, he may consider withdrawal.
5. If fraud results in misstatement, consider impact on report.

Question 6

Define management override of controls?

Answer 6

It means the ability of management to overrule prescribed policies and procedures to prepare fraudulent financial statements even where controls otherwise appear to operate effectively.
Risk of management override of controls exists in every entity.

Question 7

What are the techniques used in overriding of controls?

Answer 7

1. Recording fictitious journal entries
2. Inappropriately changing assumptions and judgements
3. Advancing or delaying recognition of events and transactions
4. Altering records and terms.

Question 8

What are the audit procedures to address risk of management override of controls?

Answer 8

1. Test the appropriateness of journal entries:
   Make inquiries about any unusual activity, select journal entries made at year end and consider the need to test them throughout the period.
2. Review accounting estimates:
   Evaluate whether the judgements indicate bias. If so, auditor shall evaluate the accounting estimates. Perform a review of assumptions related to significant accounting estimates.
3. Evaluate business rationale for significant transactions.