Fraud And The Role Of External Auditor

Question 1

Fraud

Answer 1

Fraud and the Role of the External Auditor

Definition of Fraud
Fraud is an intentional act using deception to gain an unjust or illegal advantage, distinguished from error which is a genuine mistake or omission.

Objective of External Audit
The primary objective of a statutory audit is to express an opinion on the truth and fairness of the financial statements, not primarily to prevent or detect fraud.

Auditor’s Concern with Fraud
The auditor is concerned with fraud only to the extent that it might impact the financial statements, focusing on the risk of material fraud.

Responsibility for Preventing and Detecting Fraud
1. Management: Primarily responsible for establishing systems and controls to prevent or detect fraud and errors.
2. Internal Audit: Monitors management’s systems and controls, and may review the entity’s exposure to error or fraud or undertake special investigations.

ISA 240
ISA 240 discusses the auditor’s responsibilities regarding fraud, including identifying and assessing the risks of material misstatement due to fraud.

Fraud and Error

Fraud and error are two distinct concepts in the context of auditing.

Fraud
- Definition: Fraud is an intentional act by one or more individuals, involving the use of deception to gain an unjust or illegal advantage.
- Characteristics: Fraud is intentional, involves deception, and is aimed at gaining an unfair advantage.
- Examples: Misrepresentation of financial information, theft, embezzlement, and other intentional acts that distort the financial statements.

Error
- Definition: Error is an unintentional mistake or omission that occurs due to a genuine mistake or lack of knowledge.
- Characteristics: Error is unintentional, may result from a mistake or omission, and is not aimed at gaining an unfair advantage.
- Examples: Clerical mistakes, accounting errors, and other unintentional mistakes that affect the financial statements.

Objective of a Statutory Audit
The primary objective of a statutory audit (external audit) is to express an opinion on the truth and fairness of the financial statements. The auditor’s main concern is to ensure that the financial statements accurately reflect the financial position and performance of the entity.

Auditor’s Responsibility Regarding Fraud
While the auditor is not primarily responsible for preventing or detecting fraud, they must consider the risk of material fraud that could impact the financial statements. The auditor’s responsibility is to identify and assess the risks of material fraud and design audit procedures to address those risks.

Management’s Responsibility
It is primarily the responsibility of management to establish systems and controls to prevent or detect fraud and errors. Management must design and implement internal controls to mitigate the risks of fraud and errors.

Internal Audit’s Role
Internal audit may be involved in monitoring the entity’s systems and controls, reviewing the entity’s exposure to error or fraud, and conducting special investigations into suspected error or fraud.

ISA 240
ISA 240 (The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements) provides guidance on the auditor’s responsibilities regarding fraud. The standard requires the auditor to:

1. Identify and assess the risks of material fraud.
2. Design audit procedures to address those risks.
3. Evaluate the effectiveness of the entity’s internal controls.
4. Communicate with management and those charged with governance about the risks of material fraud.

By understanding the differences between fraud and error, and the respective responsibilities of management, internal audit, and external audit, entities can better manage the risks of material misstatement and ensure the accuracy and reliability of their financial statements.