Fraud And Responsibilities Of The Auditor Flashcards
Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive or pressure to
commit fraud, a perceived opportunity to do so and some rationalization of the act. Explain with examples.
Fraud, whether fraudulent financial 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 financial 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 financial 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 specific deficiencies
in internal control.
● 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 sufficient
pressure on them.
Detection of manipulation of accounts with a view to presenting a false state of affairs is a task requiring great
tact and intelligence. Explain stating clearly how this type of fraud is generally committed.
Manipulation of Accounts: Detection of manipulation of accounts with a view to presenting a false state of affairs 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 insufficient profits;
(c) to withhold declaration of dividend even when there is adequate profit (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 profits.
Fraudulent financial reporting often involves management override of
controls that otherwise may appear to be operating effectively. Fraud can be
committed by management overriding controls using such techniques as:
♦ Recording fictitious 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 financial statements of
events and transactions that have occurred during the reporting period.
♦ Concealing, or not disclosing, facts that could affect the amounts recorded in
the financial statements.
♦ Engaging in complex transactions that are structured to misrepresent the
financial position or financial performance of the entity.
♦ Altering records and terms related to significant and unusual transactions.
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 who are usually more able
to disguise or conceal misappropriations in ways that are difficult to detect. Misappropriation of assets can be
accomplished in a variety of ways. Analyse and Explain
It 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 who are usually more able to disguise or conceal misappropriations
in ways that are difficult to detect. Misappropriation of assets can be accomplished in a variety of ways including:
● Embezzling receipts (for example, misappropriating collections on accounts receivable or diverting receipts in
respect of written-off accounts to personal bank accounts).
● Stealing physical assets or intellectual property (for example, stealing inventory for personal use or for sale,
stealing scrap for resale, colluding with a competitor by disclosing technological data in return for
payment).personal use or for sale, stealing scrap for resale, colluding with a competitor by disclosing
technological data in return for payment).
● Causing an entity to pay for goods and services not received (for example, payments to fictitious vendors,
kickbacks paid by vendors to the entity’s purchasing agents in return for inflating prices, payments to fictitious
employees).
● Using an entity’s assets for personal use (for example, using the entity’s assets as collateral for a personal loan
or a loan to a related party).
There are many ways for cash defalcation, one of which is by suppressing cash receipts. List out few techniques
of how the receipts are suppressed.
Defalcation of Cash:
Defalcation of cash has been found to perpetrate generally in the following ways:
Suppressing cash receipts.
Few techniques of how receipts are suppressed are:
i. Teeming and Lading: Amount received from a customer being misappropriated; also to prevent its detection
the money received from another customer subsequently being credited to the account of the customer who has
paid earlier. Similarly, moneys received from the customer who has paid thereafter being credited to the account
of the second customer and such a practice is continued so that no one account is outstanding for payment for
any length of time, which may lead the management to either send out a statement of account to him or
communicate with him.
ii. Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customers’ accounts and
misappropriating amount paid by them.
iii. Writing off as debts in respect of such balances against which cash has already been received but has been
misappropriated.
iv. Not accounting for cash sales fully.
v. Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees, etc.
vi. Writing down asset values in entirety, selling them subsequently and misappropriating the proceeds.
Fraud Risk Factors are the events or conditions that indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
Further, the nature of the industry or the entity’s operations also provides opportunities to engage in fraudulent
financial reporting. List out some of the cases from where theses opportunities may arise.
Fraud Risk Factors - Opportunities:
The nature of the industry or the entity’s operations provides opportunities to engage in fraudulent financial reporting
that can arise from the following:
1. Significant related-party transactions not in the ordinary course of business or with related entities not
audited or audited by another firm.
2. A strong financial presence or ability to dominate a certain industry sector that allows the entity to
dictate terms or conditions to suppliers or customers that may result in inappropriate or non-arm’s-length
transactions.
3. Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or
uncertainties that are difficult to corroborate.
4. Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult
“substance over form” questions.
5. Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for which there
appears to be no clear business justifi cation.
Fraud Risk Factors are the events or conditions that indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
Financial stability or profitability is threatened by economic,
industry, or entity operating conditions, such as (or as indicated by):
Mention some insentives/pressure
- High degree of competition or market saturation, accompanied by declining
margins. - High vulnerability to rapid changes, such as changes in technology, product
obsolescence, or interest rates. - Significant declines in customer demand and increasing business failures in
either the industry or overall economy. - Operating losses making the threat of bankruptcy, foreclosure, or hostile
takeover imminent. - Recurring negative cash flows from operations or an inability to generate cash
flows from operations while reporting earnings and earnings growth. - New accounting, statutory, or regulatory requirements.
Fraud Risk Factors are the events or conditions that indicate an incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
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.
Mention some attitude/rationalization
- Known history of violations of securities laws or other laws and regulations.
- Excessive interest by management in maintaining or increasing the entity’s
inventory price or earnings trend. - Management failing to remedy known significant deficiencies in internal
control on a timely basis. - An interest by management in employing inappropriate means to minimize
reported earnings for tax-motivated reasons. - The owner-manager makes no distinction between personal and business
transactions.
The relationship between management and the current or predecessor auditor
is strained, as exhibited by the following:
• Frequent disputes with the current or predecessor auditor on
accounting, auditing, or reporting matters.
• Unreasonable demands on the auditor, such as unrealistic time
constraints regarding the completion of the audit or the issuance of the
auditor’s report.
• Restrictions on the auditor that inappropriately limit access to people
or information or the ability to communicate effectively with those
charged with governance.
• Domineering management behavior in dealing with the auditor,
especially involving attempts to influence the scope of the auditor’s
work or the selection or continuance of personnel assigned to or
consulted on the audit engagement.
Write the circumstances that indicate the possibility of fraud due to problematic or unusual relationships
between the auditor and management.
Problematic or unusual relationships between the auditor and management, include:
1. Denial of access to records, facilities, certain employees, customers, vendors, or others from whom audit
evidence might be sought.
2. Denial of access to key IT operations staff and facilities, including security, operations, and systems development
personnel.
3. Undue time pressures imposed by management to resolve complex or contentious issues.
4. Unusual delays by the entity in providing requested information.
5. Unwillingness to facilitate auditor access to key electronic files for testing through the use of computer-assisted
audit techniques.
6. An unwillingness to add or revise disclosures in the financial statements to make them more complete and
understandable.
7. An unwillingness to address identified deficiencies in internal control on a timely basis.
Write any five circumstances of conflicting or missing evidence that indicate the possibility of fraud.
Conflicting or missing evidence, including:
1. Missing documents.
2. Documents that appear to have been altered.
3. Significant unexplained items on reconciliations.
4. Unusual discrepancies between the entity’s records and confirmation replies.
5. Large numbers of credit entries and other adjustments made to accounts receivable records.
6. Missing or non-existent cancelled cheques in circumstances where cancelled cheques are ordinarily returned to
the entity with the bank statement.
7. Missing inventory or physical assets of significant magnitude.
8. Unavailable or missing electronic evidence, inconsistent with the entity’s record retention practices or policies.
Write circumstances of discrepancies in the accounting records that indicate the possibility of fraud
• Transactions that are not recorded in a complete or timely manner or
are improperly recorded as to amount, accounting period, classification,
or entity policy.
• Unsupported or unauthorized balances or transactions.
• Last-minute adjustments that significantly affect financial results.
• Evidence of employees’ access to systems and records inconsistent with
that necessary to perform their authorized duties.
• Tips or complaints to the auditor about alleged fraud.
You notice a misstatement resulting from fraud or suspected fraud during the
audit and conclude that it is not possible to continue the performance of
audit. As a statutory Auditor, how would you deal?
the auditor shall:
(a) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to
report to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement, where
withdrawal is possible under applicable law or regulation; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those charged
with governance the auditor’s withdrawal from the engagement and the
reasons for the withdrawal; and
(ii) Determine whether there is a professional or legal requirement to
report to the person or persons who made the audit appointment or, in
some cases, to regulatory authorities, the auditor’s withdrawal from the
engagement and the reasons for the withdrawal.
There are many ways for cash defalcation, one of which is by inflating cash payments. List out few techniques
of how the payments are inflated.
Examples of inflation of payments:
(1) Making payments against fictitious vouchers.
(2) Making payments against vouchers, the amounts whereof have been
inflated.
(3) Manipulating totals of wage rolls either by including therein names of
dummy workers or by inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the excess
in the totals of the detailed columns so that cross totals show agreement
There are numerous ways of manipulation of accounts . List out some of the methods
There are numerous ways of committing this type of fraud. Some of the methods are
given below:
(i) inflating or suppressing purchases and expenses;
(ii) inflating or suppressing sales and other items of income,
(iii) inflating or deflating 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
