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WHAT ARE WE GOING TO STUDY
What is fraud
Types of error and fraudDetection of fraud and error- duty
of auditor
CA KAN
IKA K
HETANFraud and the
auditor
Detection of fraud and error- dutyof auditor
Fraud risk factor
Possibility of fraud
Audit ReportUnable to continue the
Engagement2
CA KAN
IKA K
HETAN
DEFINITION
(SA) 240 “The Auditor’s Responsibilities Relating to Fraud inan Audit of Financial Statements”
“an intentional act by one or more individuals amongmanagement, those charged with governance, employees, orthird parties, involving the use of deception to obtain anunjust or illegal advantage”
Two types of intentional misstatements are relevant to theauditor– misstatements resulting from fraudulent financial
reporting
misstatements resulting from misappropriation of assets.
Characteristics of Fraud
Fraud is Intentional
Fraud is a broad legal concept
CA KAN
IKA K
HETAN
(SA) 240 “The Auditor’s Responsibilities Relating to Fraud inan Audit of Financial Statements”
“an intentional act by one or more individuals amongmanagement, those charged with governance, employees, orthird parties, involving the use of deception to obtain anunjust or illegal advantage”
Two types of intentional misstatements are relevant to theauditor– misstatements resulting from fraudulent financial
reporting
misstatements resulting from misappropriation of assets.
Characteristics of Fraud
Fraud is Intentional
Fraud is a broad legal concept
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CA KAN
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HETAN
WHY DO THEY COMMIT FRAUD?
Financial obligations/ Pressure. Management’s unrealistic goals. Dissatisfied Employees or Lack of motivation
among employees. Name game (eg. management using power of
authority by asking employees to do somethingillegal).
Opportunity to commit fraud.
CA KAN
IKA K
HETAN
Financial obligations/ Pressure. Management’s unrealistic goals. Dissatisfied Employees or Lack of motivation
among employees. Name game (eg. management using power of
authority by asking employees to do somethingillegal).
Opportunity to commit fraud.
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HETAN
LEGAL CONCEPT OF FRAUD
FRAUD
Fraudulent financialreporting
Misappropriation ofassets
CA KAN
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HETAN
Fraud, whether fraudulent financial reporting ormisappropriation of assets, involves incentive orpressure to commit fraud, a perceived opportunity to doso and some rationalization of the act.
Misappropriationof goods Defalcation of cash
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FRAUDULENT FINANCIAL REPORTING
Fraudulentfinancialreporting
Manipulation/Falsification/Alteration
Manipulation, falsification (includingforgery), or alteration of accountingrecords or supporting documentationfrom which the financial statements areprepared.
Misrepresentation in or intentionalomission from, the financial statementsof events,transactions or other significantinformation.
Intentional misapplication ofaccounting principles relating toamounts, classification,manner of presentation, or disclosure.
CA KAN
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HETAN
Manipulation/Falsification/Alteration
Misrepresentation/Intentional Omission
Intentionalmisapplication of
accounting principles
Manipulation, falsification (includingforgery), or alteration of accountingrecords or supporting documentationfrom which the financial statements areprepared.
Misrepresentation in or intentionalomission from, the financial statementsof events,transactions or other significantinformation.
Intentional misapplication ofaccounting principles relating toamounts, classification,manner of presentation, or disclosure.
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CA KAN
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HETAN
MANIPULATION OF ACCOUNTS Generally management personnel in higher management cadre are associated
with this type of fraud and this is perpetrated in methodical way.
This type of fraud is generally committed:
to avoid incidence of income-tax or other taxes;
for declaring a dividend when there are insufficient profits;
to withhold declaration of dividend even when there is adequate profit
for receiving higher remuneration where managerial remuneration ispayable by reference to profits.
There are numerous ways of committing this type of fraud. Some of themethods are
inflating or suppressing purchases and expenses;
inflating or suppressing sales and other items of income,
inflating or deflating the value of closing inventory;
failing to adjust outstanding liabilities or prepaid expenses; and
charging items of capital expenditure to revenue or by capitalisingrevenue expenses.
CA KAN
IKA K
HETAN
Generally management personnel in higher management cadre are associatedwith this type of fraud and this is perpetrated in methodical way.
This type of fraud is generally committed:
to avoid incidence of income-tax or other taxes;
for declaring a dividend when there are insufficient profits;
to withhold declaration of dividend even when there is adequate profit
for receiving higher remuneration where managerial remuneration ispayable by reference to profits.
There are numerous ways of committing this type of fraud. Some of themethods are
inflating or suppressing purchases and expenses;
inflating or suppressing sales and other items of income,
inflating or deflating the value of closing inventory;
failing to adjust outstanding liabilities or prepaid expenses; and
charging items of capital expenditure to revenue or by capitalisingrevenue expenses.
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HETAN
MISAPPROPRIATION OF ASSETS
It involves the theft of an entity’s assets and is often perpetrated byemployees in relatively small and immaterial amounts.
Misappropriation of assets can be accomplished in a variety of waysincluding:
Embezzling receipts
Stealing physical assets or intellectual property
Causing an entity to pay for goods and services not received
Using an entity’s assets for personal use Misappropriation of assets is often accompanied by
false or misleading records or documents in order to conceal the fact.
It includes Misappropriation of goods: Fraud in the form ofmisappropriation of goods is still more difficult to detect Apart fromthe various requirements of record keeping about the physicalquantities and their periodic checks, there must be rules andprocedures for allowing persons inside the area where goods are keptalong with internal securities for employees in charge.
CA KAN
IKA K
HETAN
It involves the theft of an entity’s assets and is often perpetrated byemployees in relatively small and immaterial amounts.
Misappropriation of assets can be accomplished in a variety of waysincluding:
Embezzling receipts
Stealing physical assets or intellectual property
Causing an entity to pay for goods and services not received
Using an entity’s assets for personal use Misappropriation of assets is often accompanied by
false or misleading records or documents in order to conceal the fact.
It includes Misappropriation of goods: Fraud in the form ofmisappropriation of goods is still more difficult to detect Apart fromthe various requirements of record keeping about the physicalquantities and their periodic checks, there must be rules andprocedures for allowing persons inside the area where goods are keptalong with internal securities for employees in charge.
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HETAN
DEFALCATION OF CASH
By inflating cash payments:
By suppressing cash receipts:
Few techniques of how receipts are suppressed are:
1. Teeming and Lading
2. Adjusting unauthorised or fictitious rebates, allowances, discounts,etc. to customer’ accounts and misappropriating amount paid bythem.
3. Writing off as debts in respect of such balances against which cashhas already been received but has been misappropriated.
4. Not accounting for cash sales fully.
5. Not accounting for miscellaneous receipts, e.g., sale of scrap,quarters allotted to the employees, etc.
6. Writing down asset values in entirety, selling them subsequentlyand misappropriating the proceeds.
By casting wrong totals in the cash book.
CA KAN
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HETAN
By inflating cash payments:
By suppressing cash receipts:
Few techniques of how receipts are suppressed are:
1. Teeming and Lading
2. Adjusting unauthorised or fictitious rebates, allowances, discounts,etc. to customer’ accounts and misappropriating amount paid bythem.
3. Writing off as debts in respect of such balances against which cashhas already been received but has been misappropriated.
4. Not accounting for cash sales fully.
5. Not accounting for miscellaneous receipts, e.g., sale of scrap,quarters allotted to the employees, etc.
6. Writing down asset values in entirety, selling them subsequentlyand misappropriating the proceeds.
By casting wrong totals in the cash book.9
CA KAN
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TEEMING AND LADING:
Teeming and Lading: It is a techniques of suppressing cashreceipts in the organisation. It covers:
Amount received from a customer being misappropriated;
to prevent its detection the money received from anothercustomer subsequently being credited to the account of thecustomer who has paid earlier.
Similarly, moneys received from the customer who has paidthereafter being credited to the account of the secondcustomer and such a practice is continued so that no oneaccount is outstanding for payment for any length of time,which may lead the management to either send out astatement of account to him or communicate with him.
CA KAN
IKA K
HETAN
Teeming and Lading: It is a techniques of suppressing cashreceipts in the organisation. It covers:
Amount received from a customer being misappropriated;
to prevent its detection the money received from anothercustomer subsequently being credited to the account of thecustomer who has paid earlier.
Similarly, moneys received from the customer who has paidthereafter being credited to the account of the secondcustomer and such a practice is continued so that no oneaccount is outstanding for payment for any length of time,which may lead the management to either send out astatement of account to him or communicate with him.
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DETECTION OF FRAUD AND ERROR – DUTYOF AN AUDITOR
SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements”,
the primary responsibility for the prevention and detection of fraud rests with boththose charged with governance of the entity and management.
An auditor conducting an audit in accordance with SAs is responsible for obtainingreasonable assurance that the financial statements taken as a whole are free frommaterial misstatement, whether caused by fraud or error.
The auditor’s ability to detect a fraud depends on factors such as the skillfulness ofthe perpetrator, the frequency and extent of manipulation, the degree of collusioninvolved, the relative size of individual amounts manipulated, and the seniority ofthose individuals involved.
When obtaining reasonable assurance, the auditor is responsible for maintaining anattitude of professional skepticism throughout the audit, considering the potential formanagement override of controls and recognizing the fact that audit procedures thatare effective for detecting error may not be effective in detecting fraud.
If the auditor can prove with the help of his papers (documentation) that he hasfollowed adequate procedures necessary for the proper conduct of an audit, hecannot be held responsible for the same. If however, the same cannot be proved, hewould be held responsible
CA KAN
IKA K
HETAN
SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements”,
the primary responsibility for the prevention and detection of fraud rests with boththose charged with governance of the entity and management.
An auditor conducting an audit in accordance with SAs is responsible for obtainingreasonable assurance that the financial statements taken as a whole are free frommaterial misstatement, whether caused by fraud or error.
The auditor’s ability to detect a fraud depends on factors such as the skillfulness ofthe perpetrator, the frequency and extent of manipulation, the degree of collusioninvolved, the relative size of individual amounts manipulated, and the seniority ofthose individuals involved.
When obtaining reasonable assurance, the auditor is responsible for maintaining anattitude of professional skepticism throughout the audit, considering the potential formanagement override of controls and recognizing the fact that audit procedures thatare effective for detecting error may not be effective in detecting fraud.
If the auditor can prove with the help of his papers (documentation) that he hasfollowed adequate procedures necessary for the proper conduct of an audit, hecannot be held responsible for the same. If however, the same cannot be proved, hewould be held responsible
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CA KAN
IKA K
HETAN
FRAUD RISK FACTORS
SA 240 defines Fraud Risk Factors as events or conditions thatindicate an incentive or pressure to commit fraud or provide anopportunity to commit fraud.
Three types of fraud risk factors:
Incentives/pressures: High competition, vulnerabilities totechnology changes, threat of bankruptcy, new statutoryrequirements , known future employee payoff, promotions,compensations etc.
Opportunities: Related party transactions, Entries based onestimates that involve subjective judgments, large amount ofcash on hand, fixed assets which are small in size etc
Attitudes/rationalizations: Tolerance of petty thefts, knownhistory of violation, the owner or manager makes no distinctionbetween personal and business transactions, restrictions onauditor that limit access to people or information etc.
CA KAN
IKA K
HETAN
SA 240 defines Fraud Risk Factors as events or conditions thatindicate an incentive or pressure to commit fraud or provide anopportunity to commit fraud.
Three types of fraud risk factors:
Incentives/pressures: High competition, vulnerabilities totechnology changes, threat of bankruptcy, new statutoryrequirements , known future employee payoff, promotions,compensations etc.
Opportunities: Related party transactions, Entries based onestimates that involve subjective judgments, large amount ofcash on hand, fixed assets which are small in size etc
Attitudes/rationalizations: Tolerance of petty thefts, knownhistory of violation, the owner or manager makes no distinctionbetween personal and business transactions, restrictions onauditor that limit access to people or information etc. 12
CA KAN
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HETAN
CIRCUMSTANCES RELATED TO POSSIBILITY OF FRAUD
Conflicting or Missing evidenceMissing Documents, Altered documents, Significant unexplained items,Missing inventory, missing or non-existent cancelled cheques, Unavailable ormissing electronic evidence, Significant difference in ratios, etc
Missing Documents, Altered documents, Significant unexplained items,Missing inventory, missing or non-existent cancelled cheques, Unavailable ormissing electronic evidence, Significant difference in ratios, etc
Discrepancies in accounting record
Unsupported or unauthorized transactions, last minute adjustments that affectFS, Evidence of employees’ access to systems and records inconsistent with thatnecessary to perform their authorized duties, tips or complaints etc
Unsupported or unauthorized transactions, last minute adjustments that affectFS, Evidence of employees’ access to systems and records inconsistent with thatnecessary to perform their authorized duties, tips or complaints etc
CA KAN
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HETAN
OtherUnwillingness by management to permit the auditor to meet privately withthose charged with governance, Accounting policies that appear to be atvariance with industry norms, Frequent changes in accounting estimates that donot appear to result from changed circumstances.
Unwillingness by management to permit the auditor to meet privately withthose charged with governance, Accounting policies that appear to be atvariance with industry norms, Frequent changes in accounting estimates that donot appear to result from changed circumstances.
Problematic or unusual relationship between auditor and managementDenial of access to records, employees or customers, Undue time pressuresimposed by management to resolve complex or contentious Issues, Unusualdelays in providing info., An unwillingness to add or revise disclosures, Anunwillingness to address identified deficiencies etc
Denial of access to records, employees or customers, Undue time pressuresimposed by management to resolve complex or contentious Issues, Unusualdelays in providing info., An unwillingness to add or revise disclosures, Anunwillingness to address identified deficiencies etc
Missing Documents, Altered documents, Significant unexplained items,Missing inventory, missing or non-existent cancelled cheques, Unavailable ormissing electronic evidence, Significant difference in ratios, etc
Missing Documents, Altered documents, Significant unexplained items,Missing inventory, missing or non-existent cancelled cheques, Unavailable ormissing electronic evidence, Significant difference in ratios, etc
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CA KAN
IKA K
HETAN
FRAUD REPORTING
Fraud u/s 143(12) & Rule13
Fraud Involving amt. lessthan 1 crore
Report to Board/ AuditCommittee
Disclose Board’sReport
Fraud involving amt.of 1 cr or above
Report to CG
CA KAN
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HETAN
Report to Board/ AuditCommittee
Disclose Board’sReport
Within 2 days ofKnowledge, Report1. Nature of fraud
with description2. Approx amt
involved3. Parties involved
Disclose:1. Nature of fraud with
description2. Approx amt involved3. Parties involved, if
remedial action nottaken
4. Remedial action taken.
Seeking replywithin 45 daysfrom board/committee
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HETAN
REPORT TO CG OF FRAUD
Within 2 days ofknowledge, Report to
board/committee
Seeking reply within45 days
Report to CG
CA KAN
IKA K
HETAN
Reply receivedwithin stipulated time
Forward report +reply/observations +
comments to CG within 15days of receipt of such reply
Reply not receivedwithin stipulated time
Forward report + Note containingdetails of report for which failed toreceive reply/ observations to CG
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Reporting under Companies (Auditor’s Report) Order,2016 [CARO, 2016]: The auditor is also required toreport under clause (x) of paragraph 3 of Companies(Auditor’s Report) Order, 2016, whether any fraud by thecompany or any fraud on the Company by its officers oremployees has been noticed or reported during the year.If yes, the nature and the amount involved is to beindicated. (It is to be studied in detail under CompanyAudit)
CA KAN
IKA K
HETAN
Reporting under Companies (Auditor’s Report) Order,2016 [CARO, 2016]: The auditor is also required toreport under clause (x) of paragraph 3 of Companies(Auditor’s Report) Order, 2016, whether any fraud by thecompany or any fraud on the Company by its officers oremployees has been noticed or reported during the year.If yes, the nature and the amount involved is to beindicated. (It is to be studied in detail under CompanyAudit)
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HETAN
AUDITOR UNABLE TO CONTINUE THEENGAGEMENT
If, as a result of a misstatement resulting from fraud or suspected fraud, theauditor encounters exceptional circumstances that bring into question theauditor’s ability to continue performing the audit, the auditor shall:
Determine the professional and legal responsibilities applicable in thecircumstances, including whether there is a requirement for the auditor toreport to the person or persons who made the audit appointment or, in somecases, to regulatory authorities;
Consider whether it is appropriate to withdraw from the engagement,where withdrawal is possible under applicable law or regulation; and
If the auditor withdraws:
Discuss with management the auditor’s withdrawal from theengagement and the reasons for the withdrawal; and
Determine whether there is a professional or legal requirement to reportto the person or persons who made the audit appointment or, in somecases, to regulatory authorities, the auditor’s withdrawal from theengagement and the reasons for the withdrawal.
CA KAN
IKA K
HETAN
If, as a result of a misstatement resulting from fraud or suspected fraud, theauditor encounters exceptional circumstances that bring into question theauditor’s ability to continue performing the audit, the auditor shall:
Determine the professional and legal responsibilities applicable in thecircumstances, including whether there is a requirement for the auditor toreport to the person or persons who made the audit appointment or, in somecases, to regulatory authorities;
Consider whether it is appropriate to withdraw from the engagement,where withdrawal is possible under applicable law or regulation; and
If the auditor withdraws:
Discuss with management the auditor’s withdrawal from theengagement and the reasons for the withdrawal; and
Determine whether there is a professional or legal requirement to reportto the person or persons who made the audit appointment or, in somecases, to regulatory authorities, the auditor’s withdrawal from theengagement and the reasons for the withdrawal.
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