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The Auditor - S Responsibilities - Chapter 3

The auditor is responsible for obtaining reasonable assurance that a company's financial statements are free of material misstatement, whether caused by error or fraud. To do so, the auditor must assess the risks of material misstatement during planning and address higher risk areas with appropriate audit procedures. Material misstatements could arise from errors, fraud, or noncompliance with laws and regulations. Fraud involves intentional deception and can include improper revenue recognition, expense manipulation, or asset overstatement. The auditor evaluates any material misstatements found and determines whether the financial statements or their audit report need revision. Management is responsible for internal controls over financial reporting and disclosing any known fraud to the auditor.

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839 views38 pages

The Auditor - S Responsibilities - Chapter 3

The auditor is responsible for obtaining reasonable assurance that a company's financial statements are free of material misstatement, whether caused by error or fraud. To do so, the auditor must assess the risks of material misstatement during planning and address higher risk areas with appropriate audit procedures. Material misstatements could arise from errors, fraud, or noncompliance with laws and regulations. Fraud involves intentional deception and can include improper revenue recognition, expense manipulation, or asset overstatement. The auditor evaluates any material misstatements found and determines whether the financial statements or their audit report need revision. Management is responsible for internal controls over financial reporting and disclosing any known fraud to the auditor.

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AUDITORS

RESPONSIBILITY

Auditors Responsibility is to design


the audit to provide reasonable
assurance of detecting material
misstatements in the financial
statements

The misstatements may emanate


from:
1. Error
2. Fraud
3. Noncompliance with Laws and
Regulations

ERROR
Refers to unintentional
mistatements in the
financial statements
Including the omission of
an amount or a disclosure

ERRORS ARE:
Mathematical or clerical mistakes in the
underlying records and accounting data
An incorrect accounting estimate arising from
oversight or misinterpretation of facts
Mistake in the application of accounting policies

FRAUD
-refers to 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.

FRAUD
Auditor is primarily concerned with:
fraudulent acts that cause a material
misstatement in the financial statements
Types of Fraud
1. Fraudulent financial reporting
2. Misappropriation of assets or
employees fraud

SYSTEM
OF
QUALITY CONTROL

1. Fraudulent financial reportinginvolves intentional


misstatements or omissions of
amounts or disclosures in the
financial statements to deceive
financial statement users
- known as management fraud

Management Fraud involves:


1. Manipulation, falsification or
alteration of records or documents
2. Misrepresentation in or intentional
omission of the effects of
transactions from records or
documents
3. Recording of transactions without
substance
4. Intentional misapplication of
accounting policies

Financial statement fraud


is deliberate misrepresentation, misstatement or
omission of financial statement data for the purpose
of misleading the reader and creating a false
impression of an organization's financial strength.
Public and private businesses commit financial
statement fraud to secure investor interest or obtain
bank approvals for financing, as justification for
bonuses or increased salaries or to meet
expectations of shareholders.
Upper management is usually at the center of
financial statement fraud because financial
statements are created at the management level.

Methods
Financial statement frauds fall into general
categories. These include
a. improper revenue recognition,
b. manipulation of liabilities,
c. manipulation of expenses,
d. improper disclosures on financial
statements and
e. overstating assets

Improper Revenue Recognition


The most common scheme used in financial statement fraud involves
manipulation of revenue figures.
According to a survey by Deloitte of Accounting and Auditing
Enforcement Releases (AAER) filed by the SEC from 2000 through
2008, improper revenue recognition was recognized as the scheme
employed in 38 percent of the 403 cases studied.

Schemes to manipulate revenue figures typically involve posting


sales before they are made or prior to payment.
Examples include recording product shipments to company-owned
facilities as sales, re-invoicing past due accounts to improve the age
of receivables, pre-billing for future sales and duplicate billings

Manipulating Expenses
Another fraud involving financial statements is the deliberate
manipulation of expenses.
The Deloitte survey of AAER filings by the SEC shows that 12 percent
involved expense manipulation and 8 percent manipulation of liabilities.
An example of manipulating expenses is to capitalize normal operating
expenses. This scheme is an improper method to delay recognition of the
expense and artificially raise income figures.
An example of this type of scheme is the WorldCom scandal, where
significant operating expenses were listed as capital on the balance sheet.
Concealment and manipulation of liabilities frauds include failure to record
accounts payables or report regular expenses on financial statements.
Keeping certain liabilities, leaving notes or loans off-the-books and writing
off money lent to executives are also common methods of fraud.

Improper Disclosures
Disclosure frauds are commonly based on
misrepresenting the company and making
false representations in press releases and
other company filings.
Making false statements in the commentary
sections of annual reports of other
regulatory filings are another source for
improper disclosures.
Some disclosures might be intentionally
confusing or obscure and impossible to
completely understand

2. Misappropriation of assets or
employee fraud
Involves theft of an entitys assets
committed by the entitys employees
This includes:
a. Embezzling receipts
b. Stealing entitys assets such as cash,
marketable securities, and inventory
c. Lapping of accounts receivable
Note: often accompanied by false or
misleading records or documents in order to
conceal the fact that the assets are missing

Overstating Assets
Overstatement of current assets on
financial statements and failure to
record depreciation expenses are often
employed as methods of fraud.
Overstatement of inventory and
accounts receivables are also
commonly used to inflate company
assets on fraudulent statements

Fraud involves
Motivation to commit it
A perceived opportunity to do so
Distinguish Fraud from Error
- Whether the underlying cause of
misstatement in the financial statements
is intentional or unintentional.

Responsibility of Management and Those


charged with governance
Management to establish a control
environment and to implement internal
control policies and procedures designed
to ensure the detection and prevention of
fraud.
Individuals charged with governance of an
entity to ensure the integrity of an entitys
accounting and financial reporting system
and that appropriate controls are in place.

Auditors Responsibility
- To design the audit to obtain reasonable
assurance that the financial statements
are free from material misstatement
whether caused by error or fraud.
Planning Phase
1. Auditor should make inquiries of management about
the possibility of misstatement due to fraud or error:
a. Management s assessment of risk due to fraud
b. Controls established to address the risks
c. Any material error or fraud that has affected the
entity or suspected fraud that the entity is
investigating.

2. Auditor should assess the risk that


fraud and error may cause the FS to
contain material misstatements
PAS 240 requires the auditor to
specifically assess the risk of
material misstatements due to fraud
and consider that assessment in
designing the audit procedures to be
performed

Fraud risks factors


- Identify events or conditions that
provide an opportunity
- A motive or a means to commit fraud
- Indicate that fraud may already have
occurred

Auditors Professional judgments may be


influenced :
The auditor may approach the audit with
heightened level of professional skepticism
The auditors ability to assess control risk at
less than high level may be reduced and he
should be sensitive to the ability of the
management to override controls
The audit team may be selected in ways that
ensure that the knowledge, skill and ability of
personnel assigned significant responsibilities
are commensurate with the auditors
assessment of risk

- The auditor may decide to


consider management selection and
application of significant accounting
policies, particularly those related to
income determination and asset
valuation.

Testing Phase
3. During the course of the audit, the
auditor may encounter circumstances
that may indicate the possibility of fraud
or error
4. After identifying material misstatement
in the FS
Resulted from a fraud or an error.
Errors will result to adjustments of FS
Fraud may have other implications on an audit

Not Material effect of Fraud


Auditor should
Refer the matter to appropriate level of
management
Be satisfied that, the fraud has no other
implications for other aspects of the
audit and that those implications have
been adequately considered

Material effect of the Fraud or


unable to evaluate
The Auditor should:
- consider implication for other
aspects of the audit particularly the
reliability of management
representation
- discuss the matter and the
approach to further investigation with
an appropriate level of that is at least
one level above those involved

- attempt to obtain evidence to


determine whether a material fraud
in fact exists and if so their effects
and
Suggest that the client consult with
legal counsel about question of law

COMPLETION PHASE
5. The auditor should obtain a written
representation from the clients
management that
It acknowledge the responsibility for the
implementation and operation of
accounting and internal control system
that are designed to prevent and detect
fraud and error

It believes the effects of those uncorrected


financial statements aggregated by the
auditor during the audit are immaterial to the
FS taken as a whole
It has disclosed to the auditor all significant
facts relating to frauds or suspected frauds
known to management that may have
affected the entity
It has disclosed to the auditor the results of
its assessment of the risk that the FS may be
materially misstated as a result of fraud.

COMPLETION PHASE
6. Material Errors or fraud exist
He should request the management to
revise the FS, otherwise he will express
a qualified or adverse opinion
7. Unable to evaluate the effect of fraud
on the FS
because of limitation of scope, he
should either qualify or disclaim his
opinion on the FS

Noncompliance with Laws and


Regulations
Noncompliance
Refers to acts of omission or commission by
the entity being audited, either intentional or
unintentional, which are contrary to the
prevailing laws or regulations.
Includes transactions entered into by or in the
name of , the entity or on its behalf by its
management or employees.
Example: Tax evasion, violation of
environmental protection laws, inside trading of
securities

Managements
Responsibilities
PAS 250
The responsibility for the prevention and
detection of noncompliance rests with
management

Following policies and


procedures
Monitoring legal requirements and
ensuring that operating procedures
are designed to meet these
requirements
Instituting and operating appropriate
system of internal control
Developing, publicizing and following
a Code of Conduct

Ensuring employees are properly


trained and understand the Code of
Conduct
Monitoring compliance with the Code
of Conduct and acting appropriately
to discipline employees
Engaging legal advisors in monitoring
legal requirements
Maintaining a register of significant
laws with witch the entity has to
comply within its particular industry
and a record of complains

Auditors Responsibility
Planning Phase
1 Obtain a general understanding of the
legal and regulatory framework
applicable to the entity.
2. Design procedures to help identify
instances of noncompliance with those
laws and regulations where
noncompliance should be considered
when preparing FS

3. Design audit procedures to obtain


sufficient appropriate audit evidence
about compliance with those laws
and regulations generally recognized
by the auditor
Effect on the determination of material
amounts and disclosures in FS

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