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54 views11 pagesFraud and Errors
Abc
Uploaded by
Anmol poudelCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
/ 11
‘Scanned with CamScanner Such a ‘situation could occur when, due to pressures to meet market
‘expectations or a desire to maximize compensation based on performance,
‘management intentionally takes positions that lead to fraudulent financial
reporting by materially misstating the financial statements.
‘Manipulation, falsification (including forgery), or alteration of accounting
Fecords or supporting documentation from which the financial statements:
are prepared.
Misrepresentation in or intentional omission from, the financial statements
of events, transactions or other significant information.
Intentional misapplication of accounting principles relating to amounts,
Classification, manner of presentation, or disclosure.
‘Misappropriation of Assets
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 able to disguise or
conceal misappropriations in ways that are difficult to detect.
Misappropriation of assets is often accompanied by false or misleading
records or documents in order to conceal the fact that the assets are missing
or have been pledged without proper authorization
Examples:
Embezzling receipts
Misappropriating collections on accounts receivable
Diverting receipts in respect of written-off accounts to personal bank
accounts
Stealing physical assets or intellectual property
Stealing inventory for 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
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
Using the entity’s assets as collateral for a personal loan
A loan to a related party. ‘Not accounting for cash sales fully.
Not accounting for miscellaneous receipts, e.g, sale of scrap, quarters
allotted to the employees, etc. ‘
{Writing down asset values in entirety, selling them subsequently and
a acororiig the proceed,
Manipulation of Accounts
'@It-means drawing up accounts in such a manner that the position showed
by the financial statements is different than what is actually is.
| It is done to lure investors, to declare the dividends to show favorable
position to the lenders so that the finances are not withdrawn by the
investors, orto evade the government taxes and dues.
Itmaybe done by:
Y recording fictitious entries
deep laid adjustments in the financial statements
selection of wrong accounting policies
undervaluation or overvaluation of assets
Errors simply mean mistakes that occur while writing the books of accounts.
Itis obvious that the word mistake is associated with “unintentional”.
Therefore the main distinction between fraud and error is that of
“Intention”. Frauds are intentional whereas errors are unintentional
However, the misstatements may be material even if they are due to errors.
The errors or mistakes which are committed in the journal, ledger and any
other financial statements are known as accounting errors,
For example: If a purchase transaction worth Rs. 100,000 is omitted to be
recorded, then it may cause understatement of purchases by Rs. 100,000.
(error of omission) s
‘On the basis of Nature
a. Self revealing errors
Those errors that are disclosed at the time of finalization of accounts.
7 Such as wrong totaling of ledgers, non recording of cheque deposited
bank account,
Non: self revealing errors
© Accounting errors that are not disclosed by normal procedures.
Such as errors of principles, recording of administrative salary
the head "wages” in trading account,
‘Scanned with CamScanner C ma aaa |
These mistakes that ‘due to lack of |
accounting may be due to. knowledge or
Y Such 98 a bill worth Rs. 567 was recorded as 576 oF an accountant
a tane omtets 10 count a petty expense,
Intentional Errors/ Concealed Errors.
¥ These are in the nature of "fraud.
¥_ Refer precious topic on Fraud.
©. Errors affecting trial balance
¥ Those errors which cause the difference in tallying of trial balance.
Also known as one sided errors.
Errors not affecting trial balance
t
¥ Those errors which are not disclosed by trial balance.
Y Also known as two sided errors.
¥__For example: Errors of omission, Compensating Errors ete.
‘On the basis of accounting aspect.
Y An accounting mistake in which an entry is recorded in the incorrect
account, violating the fundamental principles of accounting.
Y _Anerror of principle is a procedural error.
For example: Capital expenditure treated as revenue expenditure.
& Compensating eons:
The error that neutralizes the effect of previous error.
It happens when an error on debit side is compensated by an error on
credit side and therefore it does not have any effect on the agreement of
trial balance.
For example : When an amount of Rs. 327 to be written on debit side is
written as Rs. 237 and at the same an amount of Rs. 546 is written as Rs.
456 on the credit side.
Error
v
oe
Errors of omission in accounting occur when a bookkeeping entry has
been completely omitted from the accounting records.
For example: Purchase of Rs. 2500 recorded as Rs. 250. (or not recorded )
d. Error of commission
Y The errors which are committed while recording or posting a transaction
are called errors of commission.
Y Errors of commission may take place either in the journal or in the
subsidiary books, or in the ledger. Such errors include posting wrong
amounts, posting on wrong side of accounts, wrong totaling or carrying
forward, and wrong balancing.
For example, if purchase of goods for Rs. 10,000 is entered as Rs. 1000 in
the journal or in the ledger, such error is called errors of commission.
This NSA deals with the auditor's responsibilities relating to fraud in an audit of
financial statements.
‘The primary responsibility for the prevention and detection of fraud rests with both
Prevention and | those charged with governance of the entity and management.
Detection of Fraud | Note: Management along with TCWG are responsible for designing ond
implementing sultable internal controls that can prevent, detect and correct the
‘misstatement on timely basis.
a Page | 33
CA. Suni Joshi.
Scanned with CamScanner to conditions which may indicate possible
Geter erfuuk and a critical assessment of audit evidence,
Professional skepticism is necessary to the critical assessment of
‘evidence. This includes questioning contradictory audit evidence ang
reliability of documents and responses to inquiries and other i
obtained from management and those charged with governance. It agg
includes consideration of the sufficiency and appropriateness. of
‘evidence obtained in the light of the circumstances, for example, in the cage
where fraud risk factors exist and a single document, of a nature that
susceptible to fraud, is the sole supporting evidence for a material financial,
statement amount.
In accordance with NSA 200, the auditor shall maintain
skepticism throughout the audit, recognizing the possibility that a materish
misstatement due to fraud could exist, notwithstanding the auditor's past
‘experience of the honesty and integrity of the entity’s management and.
those charged with governance
Unless the auditor has reason to believe the contrary, the auditor may
records and documents as genuine. if conditions identified during the
cause the auditor to believe that a document may not be authentic or
terms in a document have been modified but not disclosed to the auditor,
‘auditor shall investigate further.
Where responses to inquiries of management or those charged
‘governance are inconsistent, the auditor shall investigate the inconsist
A ment
The auditor shall make inquiries of management regarding:
(@) Management's assessment of the risk that the financial statements
be materially misstated due to fraud, including the nature, extent
frequency of such assessments;
Management's process for identifying and responding to the risks
fraud in the entity, including any specific risks of fraud that
has Identified or that have been brought to its attention, or classes
‘(vansactions, account balances, or disclosures for which a risk of fraud is
likely to exi =
Scanned with CamScanner c
The auditor shall
more fraud risk factors are present.
‘on business practices and ethical behavior.
‘The auditor shall make inquiries of management, TEWG, Internal Audit
‘Function (if any) and others within the entity as appropriate, to
determine whether they have knowledge of any actual, suspected or
alleged fraud affecting the entity and their views about the risk of fraud.
‘8.Unusual or Unexpected Relationships identified (ARP)
‘The 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 dive to fraud.
uate whether the information obtained from the other risk
ssessment procedures and related activities performed indicates that one or
Risks of | Material
‘Misstatement Due to
(Para 25-27)
‘The auditor shall identify and assess the risks of material misstatement due
to fraud at the financial statement level, and at the assertion level for
‘lasses of transactions, account balances and disclosures
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
‘The auditor shall treat those assessed risks of material misstatement due to
fraud as significant risks and accordingly, to the extent not already done so,
the auditor shall obtain an understanding of the entity's related controls,
including control activities, relevant to such risks.
Responses to the
Assessed Risks of
Material
Misstatement Due to
Fraud
(Para 28-33)
The
@)
©)
©
material misstatement due to fraud at the financial statement level
In determining overall responses to address the assessed risks of material
Guditor shall determine overall responses to address the assessed risks of
tatement due to fraud at the financial statement level, the auditor shal
‘Assign and supervise personnel taking account of the knowledge, skill
‘and. ability of the individuals to be given significant engagement
Fesponsibilties and the auditor's assessment of the risks of material
misstatement due to fraud for the engagement; |
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; and
Incorporate an element of unpredictability in the selection of the nature,
timing and extent of audit procedures. |
Evaluation of Audit
(Para 34-37)
2h
nei
fin
fra
one
mi
an
‘entity, indicate a previously unrecognized risk of material misstatement due to
satuate the Implications of the misstatement in relation to other aspects of the
svat, particularly the reliability of management representations, recognizing that
~ auditor shall evaluate whether analytical procedures that are performed
ar the end of the audit, when forming an overall conclusion as to whether the
vancial statements are consistent with the auditor's understanding of the
ud.
ra auditor identifies a misstatement, the auditor shall evaluate whether such 2
etatemnent is indicative of fraud. If there is such an indication, the auditor shall
instance of fraud Is unlikely to be an isolated occurrence,
CA. Sunt Joshi.
Page | 35
Scanned with CamScanner ‘Scanned with CamScanner to the company, And the managing director has also fully
‘compensated the loss at committed by him to the company immediately after the detection of fraud.
“Suggested Answer (Hints) <
‘NSA 240 further defined the duties of the auditor to communicate these matters to the appropriate
{evel of management on timely basis, and consider the need to report such matters to those charged
with governance in such case.
Companies Act Further requires the auditor to report any accounting frauds identified during the
course of audit,
3. Give the examples of circumstances that may indicate the possibility of fraud.
‘The following are examples of circumstances that may indicate the possibility that the financial
‘statements may contain a material misstatement resulting from fraud.
Discrepancies in the | ¥ Transactions that are not recorded in a complete or timely manner or are
‘accounting records. | 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.
‘Missing documents.
Altered documents
Unavailability of other than photocopied or electronically transmitted documents
‘when documents in original form are expected to exist
Significant unexplained items on reconciliations.
Unusual balance sheet changes or changes in trends or important financial
statement ratios or relationships — for example, receivables growing faster than
revenues.
Inconsistent, vague, or implausible responses from management or employees
arising from inquiries or analytical procedures.
Unusual discrepancies between the entity's records and confirmation replies.
Large numbers of credit entries and other adjustments made to accounts
receivable records.
Missing or non-existent cancelled checks in circumstances where cancelled checks
‘are ordinarily returned to the entity with the bank statement.
Missing inventory or physical assets of significant magnitude.
Unavailable or missing electronic evidence, inconsistent with the entity's record
retention practices or policies. ~
Denial of access to records, facilities, certain employees, customers, vendors, or
‘thers from whom audit evidence might be sought.
Undue time pressures imposed by management to resolve complex or contentious
issues.
Complaints by management about the conduct of the audit or management
intimidation of engagement team members, particularly in connection with the
auditors critical assessment of audit evidence oF in the resolution of potential
disagreements with management.
Unusual delays by the entity in providing requested information,
Unwillingness to facilitate auditor access to key electronic files for testing through
the use of computer-assisted audit techniques.
Page | 37 overriding controls?
4. What techniques can be used by the management to commit frauds bY
Answer: ‘ontrols using such techniques as:
Fraud can be committed by management overriding
J pecording Regus ure etn partes lose to the end of an accounting Period
its or achieve other objectives.
IMaporopratey adketng.ssumptons and changing judements used to estimate Accoum
balances.
‘Omitting, advancing or delaying recognition in the financial statements of events Ang
‘transactions that have occurred during the reporting period.
Concealing, or not disclosing, facts that could affect the amounts recorded in the Financia)
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.
'S. How the auditor's performance is judicially viewed?
OR.
‘The court applies certain tests to determine whether or not the auditor can be held responsible for
‘non-detection of misstatements, State those tests.
Answer:
The auditor's performance is judicially viewed by applying the following tests:
‘2. whether the auditor has exercised reasonable care and skill in carrying out his work:
Whether the errors and frauds were such that they could have been detected in the ordinary
course of business.
‘whether the auditor had any reasons to suspect the existence of errors and fraud in the financial
statements;
Whether the error or fraud was so deep laid that it could not have been detected by the:
application of normal audit procedures.
In Short, auditor's performance is judicially reviewed by checking whether or not the
‘auditor has followed basic principles governing audit!
‘6. Briefly Explain “Window Dressing”
Answer: Window dressing refers to an act of improving the appearance of a company's financial
statements by manipulation of transactions. Window dressing is particularly common when @
‘business has a large number of shareholders, so that management can give the appearance of a well
un company to investors who probably do not have much day-to-day contact with the business.
‘t may also be used to obtain the loan from the lender or to lure the prospective investor,
The window dressing concept is also used by fund managers, who replace poorly-performing
securities with higher-performing ones just before the end of a reporting period, to give the
appearance of having a robust set of investments.
‘The entire concept of window dressing is clearly unethical. The auditor has to be professionally
‘skeptical to identify the possibility of window dressing, Frauds And Errors In Financial Statements:
the avait procedures,
nee tenagenart a ures Posen ed Nieuws Ova ane
coerce ort tt ic arr tn ta
/ Aithourh the level of risk of management
‘of controls will vary from entity to entity, the risk is nevertheless present in all entities. Due to the
“unpredictable way in which such override to
aon ane = could occur, tis a risk of material misstatement dive
Irrespective of the auditor's assessment of the risks of management override of controls, the auditor
‘shall design and perform audit procedures to:
(a) Test the appropriateness of journal entries recorded in the general ledger and other
adjustments made in the preparation of the financial statements. In designing and performing
audit procedures for such tests, the auditor shall:
(Make inquiries of individuals involved in the financial reporting process about
inappropriate or unusual activity relating to the processing of journal entries and other
adjustments;
Select journal entries and other adjustments made at the end of a reporting period; and
rf Gi) Consider the need to test journal entries and other adjustments throughout the period.
»
Review accounting estimates for biases and evaluate whether the circumstances producing
the bias, if any, represent a risk of material misstatement due to fraud. In performing this
review, the auditor shall
(Evaluate whether the judgments and decisions made by management in making the
accounting estimates included in the financial statements, even if they are individually
reasonable, indicate a possible bias that may represent a risk of material misstatement
due to fraud. and
w@
Perform a retrospective review of management judgments and assumptions related to
significant accounting estimates reflected in the financial statements of the prior year.
8. Explain" Teeming and Lading”
Answer: Teeming and lading is a fraud that is associated with improper use of company's receipts and
adjusting them against the prospective receipt entries. It occurs specially when the internal controls
cover cash are weak
Itis also known as short banking , delayed accounting and lapping. It involves the allocation of one
‘customers payment to another in order to make the books balance so that at the subsequent period
‘the account balance seem as tallied.
It is a method by which the person responsible for cash handling uses the money for some days and
‘shows the transaction after some time. The receipts are not deposited and accounted initially which
‘enables him to use the cash. When the subsequent receipt from another customer is received , the
cashier will deposit that money against first money used, and does not show the new amount
received, and this process will be followed regularly.
‘Another similar strategy is applied when remittances are received by means of cheques, where
‘cheques are split up to record payments. This is known as splitting cheques. Here by encashing the
cheques, less amount is credited to the debtor and rest of the amount is misappropriated.
Following internal Controls can be considered for prevention of Teeming and Lading
«The cash and cheque received should be split into two different type: cash and cheque banking in
stip.
Immediately on the receipt of payment, the receipt slip should be issued to the payer.
There should be reconciliation which should involve the matching of the income receipts/other
documentation to accounting records on the one hand and bank statements and paying-in slips
‘on the other;
There should be proper segregation of duties, The person carrying out this reconciliation should
‘not be the person who banked the income;
‘The reconciliations should be reviewed by someone independent of income processing.
a Page | 39
CA. Sunil Jos
Scanned with CamScanner ‘Frauds And Errors In Financial
‘9. Explain the concept of "kiting."
“Answer: A fraudulent act involving the alteration or issuance of
funds.
This process Is also known as check kiting. It fraudulent acthty that uses cheques aa
money from a business. i is usualy committed by a bookkeeper oF someone Slt, Wit Nets
‘company cheques and the ability to forge cheques, but when the management i itself involved oF the
‘company acts with malafide intention then it can also be used by the company to delay the payments
‘of otherwise obtain benefit with regards to payment obligations.
a check or draft with
‘When various cheques are recelved by the company, Instead of depositing all of the company income:
checks, a bookkeeper can cash one of the checks for him and put it in his own bank account. Since the
funds received through cheque were needed by the company for the payment of its expenses, there
will be shortfall for the payment of bills. The bookkeeper then writes another cheque to make the
payments knowing that there will be shortfall of funds. Before the check has a chance to clear, the
‘bookkeeper writes another check from a different company account into the main company account.
This buys the bookkeeper a few more days until the second cheque can clear. By that time, more