FRAUD

PSA 240 THE AUDITOR’S RESPONSIBILITIES

RELATING TO FRAUD IN AUDIT OF
FINANCIAL STATEMENTS
 FRAUD

• 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.
 ERROR

• Errors are unintentional misstatements or

omissions of amounts or disclosures in
the financial statements.
• They include mistakes in gathering or
processing accounting data, inaccurate
accounting estimates, and
misunderstanding or unintentional
misapplication of accounting principles.
Types of Fraud

1. Fraudulent Financial Reporting

2. Misappropriation of Assets
Fraudulent financial
reporting

 involves intentional misstatements or omissions of amounts or

disclosures in the financial statements that are designed to deceive
financial statement users.
 These are usually acts of management and may involve:
a. manipulation, falsification, or alteration of accounting records
or supporting documents from which financial statements are
prepared;
b. misrepresentation in, or intentional omission from, the
financial statements of
c. events, transactions, or other significant information; or
d. intentional misapplication of accounting principles relating to
amounts, classification, manner of presentation, or
disclosures.
Misappropriation
of Assets
• or defalcation,
• involves theft of an entity's assets when the
effect of the theft causes the financial
statements not to be presented in conformity
with GAAP.
• These acts usually involve one or more
individuals among management, employees, or
third parties, and may involve stealing assets or
causing an entity to pay for something that has
not been received.
 FRAUD RISK
FACTORS

• Events or conditions that indicate an

incentive or pressure to commit fraud or
provide an opportunity to commit fraud.
Fraud Triangle

A reason
INCENTIVES OR
PRESSURES to commit
fraud

Lack of
effective Attempt to justify
controls fraudulent
behavior

RATIONALIZATION
OPPORTUNITY OR ATTITUDE
 Management
Responsibility

• to design and implement programs and

controls to prevent, deter, and detect
fraud.
 Auditor’s
Responsibility
• To identify and assess the risks of material
misstatement of the financial statements due to fraud.
• To obtain sufficient appropriate audit evidence
regarding the assessed risks of material misstatement
due to fraud, through designing and implementing
appropriate responses.
• To respond appropriately to fraud or suspected fraud
identified during the audit.
 REASONABLE
ASSURANCE
• Due to the concealment aspects of fraud and
the need to apply judgment in evaluating fraud
risk, even a properly planned and executed
audit may fail to detect fraud.
• In expressing an audit opinion, the auditor
provides only reasonable (not absolute)
assurance that the financial statements are free
of material misstatements resulting from errors
or fraud.
 REASONABLE
ASSURANCE
• The risk of not detecting a material
misstatement resulting from fraud is higher than
the risk of not detecting one resulting from
error.
• The risk of not detecting a material
misstatement resulting from management fraud
is greater than for employee fraud because
management is in a position to manipulate
accounting records, present fraudulent financial
information, or override controls.
 REASONABLE
ASSURANCE
• Fraud is often difficult to detect because those
engaged in fraud will generally try to conceal it.
Collusion among various parties can also make
it difficult to detect fraud.
• The auditor's ability to detect fraud depends on
the skilfulness of the perpetrator, the frequency
and extent of manipulation, the degree of
collusion involved, the relative size of the
individual amounts manipulated, and the
seniority of the individuals involved.
REQUIREMENTS

• The auditor shall maintain professional skepticism

throughout the audit.
• Where responses to inquiries of management or those
charged with governance are inconsistent, the auditor
shall investigate the inconsistencies.
• Discuss among team members;
– How and where the entity’s financial statements may
be susceptible to material misstatement due to fraud
including how fraud might occur.
REQUIREMENTS

• Make inquiries of management about;

o Management assessment of risk of that the financial
statements may be materially misstated due to fraud,
including the nature, extent and frequency of such
assessments.
o Management’s process for identifying and responding to
the risks of fraud in the entity, including any specific risks
of fraud that management has identified or that have
been brought to its attention, or classes of transactions,
account balances, or disclosures for which a risk of fraud
is likely to exist.
REQUIREMENTS

Make inquiries of management about;

o Management’s communication, if any, to those charged
with governance regarding its processes for identifying
and responding to the risks of fraud in the entity.
o Management’s communication, if any, to employees
regarding its views on business practices and ethical
behavior
o Management, internal audit and others within the entity
as appropriate, to determine whether they have
knowledge of any actual, suspected or alleged fraud
affecting the entity.
REQUIREMENTS

Make inquiries of management about;

o Unless all of those charged with governance are
involved in managing the entity, the auditor shall
make inquiries of those charged with governance to
determine whether they have knowledge of any
actual, suspected or alleged fraud affecting the
entity. These inquiries are made in part to
corroborate the responses to the inquiries of
management.
REQUIREMENTS

• The auditor shall obtain an understanding

of how those charged with governance
exercise oversight of management’s
processes for identifying and responding
to the risks of fraud in the entity and the
internal control that management has
established to mitigate these risks.
• Auditor shall evaluate whether unusual
or unexpected relationships that have
been identified in performing analytical
procedures, including those related to
revenue accounts, may indicate risks of
material misstatement due to fraud.
• The auditor shall evaluate whether the
information obtained from the other risk
assessment procedures and related
activities performed indicates that one or
more fraud risk factors are present.
• When identifying and assessing the risks
of material misstatement due to fraud, the
auditor shall, based on a presumption
that there are risks of fraud in revenue
recognition, evaluate which types of
revenue, revenue transactions or
assertions give rise to such risks.
• In determining overall responses to address the assessed
risks of material misstatement due to fraud at the financial
statement level, the auditor shall;
– Assign and supervise personnel
– Evaluate whether the selection and application of
accounting policies by the entity, particularly those
related to subjective measurements and complex
transactions, may be indicative of fraudulent financial
reporting resulting from management’s effort to manage
earnings
– Incorporate an element of unpredictability in the selection
of the nature, timing and extent of audit procedures.
• Auditor shall design and perform
procedure that are responsive to
assessed risk.
• Auditor shall perform following procedure due
to risk of Management override of control;
– Test the appropriateness of journal entries, for end
of period and throughout period and inquire about
any unusual transaction.
– Review accounting estimates for biases by
evaluation and retrospective review.
– For significant transaction outside the normal course
of business, evaluate the business rationale.
• EXAMPLES