AUD 689
AUDIT AND ASSURANCE
SERVICES
TOPIC 3
Fraudulent Financial
Reporting
1
Learning Objectives
To understand the difference
between fraud and error
To identify factors contributing
towards fraud
To theory of fraud
triangle/diamond
2
FRAUD & ERROR
Concealment of Fraud
Falsificationof document –forgery of
signature, content
Destruction of documentation (Shred)
On-book frauds, manipulation of acctg
records (personal purchase debited as
entertainment; issued shipping
document for false purchase)
Concealment of Fraud
Fraud concealment will misstate
the financial statements
Difference in amount,
classification & presentation
Omission or commission in
transaction and account
Disclosure – not accordance to
accounting standards
Difference between Fraud and Error
Errors – unintentional misstatement, may involve
• Mistakes in gathering or processing data
• Unreasonable acc estimate arising from oversights of facts
or misinterpretation of facts
• Differences in the application of acc std
Fraud – intentional misstatement, may be categorized as
Fraudulent financial reporting
Manipulation, falsification or alteration of acc
records/supporting doc
Misrepresentation/ intentional omission of transaction in
the acc
Misapplication of acc records
Misappropriation of assets – theft of assets
Embezzling of cash receipts
Stealing of assets
Payment for goods or services not received
Responsibilities towards Fraud and Error
Responsibilities
Both management and auditor contributes to better
internal control as the function to detect, prevent and
correct fraud and error on timely basis
Management (integral)
◦ Installing an effective acc system
◦ Establishing effective ICS
◦ Establishing Internal audit function
◦ Appointing audit committee
◦ Establishing and implementing code of conduct among the
employees and management
Auditor (Incidental)
◦ assess risk, design audit procedures, maintain
professional skepticism
- an auditor is not an insurer, thus he does not
guarantee that the FS are free from material
misstatement
High Risk of Fraud and Error (Red Flags)
Examples of “high risk areas”
◦ Internal controls are either poor or
ignored by management
◦ Losses in inventory
◦ Unexceptionally large amount of
expenses/ purchases
◦ Management ignores any suggestions
by internal & external auditors
Auditor’s Consideration During Audit
Matters that auditors need to
consider when auditing the FS
◦Management characteristics
Dominated by one person
Management poor reputation
in business community (e.g.
Bad tactics)
Auditor’s Consideration During Audit
◦ Operating & industry
characteristics
Client < profitable than other
companies in the same industry
Fluctuations in operating result as
compared to general economic
conditions
Declining industry pattern
◦ Characteristics of the audit
engagement
Client’s transactions & balances are
difficult to audit
Steps to be Taken by Auditor’s
What should auditor do if there is
indication of fraud/error?
◦ Obtain an understanding of the nature of the
event & circumstances in which it has occurred
+ gather sufficient info to evaluate possible
effect on the FS
◦ If he believes F/E could have material effect on
FS, appropriate modified/additional procedures,
document their findings & discuss with mgmt.
◦ Report to management/ BOD /AC if they suspect
fraud
◦ Report may now become qualified
adverse, qualified, disagreement with mgmt
Disclaimer – due to limitation of scope if client trying to
conceal information.
Fraud Diamond
INCENTIVES/PRESSURE
An oppressive condition of economic distress
OPPORTUNITIES
ATTITUDE/
Able to do and hide the
wrongdoings
CAPABILITY
Fraud Diamond
INCENTIVES/PRESSURE
◦ What causes people to commit fraud. Often due to
greed for money / unreasonable targets set by
management.
OPPORTUNITIES
◦ Conditions that enable people to commit fraud such
as weak internal control
ATTITUDE/RATIONALIZATION
◦ Involves a person reconciling his/her behaviour
(rg:stealing) with the commonly accepted notions of
decency and trust
CAPABILITY
◦ The person’s position/ function that may furnish his
ability to create/ exploit an opportunity for fraud not
available to others
End of Topic 3
